Business Microeconomics Price Descrimination

Question: Describe about the Business Microeconomics for Price Descrimination. Answer: 1). Third degree price discrimination occurs when the seller is able to divide its market into two or more sub-markets on the basis of price elasticity of demand in each sub-market and hence charges different prices in two or more different sub markets. It depends on the total output and the demand conditions prevalent in that particular sub-market. a). Price mechanism under third degree price discrimination is very simple. Consumers that have low elasticity of demand will be charged highly whereas a consumer with high elasticity of the demand for the product would be charged at low prices. Assuming marginal cost (MC) is constant across given two sub-markets, irrespective it being divided or united, MC would always equal average total cost (ATC). The profit would be maximized at that price and output where MC = MR. However, when the market are separated, the price and output will be P and Q in the relatively inelastic sub-market and P1 and Q1 in the relatively elastic sub-market. A rational profit maximizing supplier would opt for price discrimination only when the profit is greater by separating sub-markets rather than combining the sub-markets. Thus, if markets are separated, MCPXY +MC1P1X1Y1 is the area of profit. When the markets combined, profit becomes MC2X2Y2 (shown in the first diagram from the right). Here we assume that the price are lower in relatively elasticsub-market than those in therelatively inelasticsub-market. This causes an outward kink in the joined demand curve which is the AR curve and a discontinuous portion in the combined MR curve (as depicted by the vertical dotted line in the above diagram).However, in case consumers from different sub-markets are willing to be a part of relatively inelastic market at the higher price, in that case, the combined demand (AR) curve shifts to the right, and because of this, there will not have the kink anymore (Case Ray, 2007). It is important to note that in all such cases, profit maximization will occur only at point where MC = MR. This implies that equilibrium would occur at a point where MR is positive for monopolist aiming profit maximization, indicating that the price will always settle in the elastic areaof the demand curve (Varian, 2010; Bernheim Whinston, 2009; Parkin, 2013) b). Price discrimination can happen only when there is no transfer of even single unit of product from one sub-market to the other. This is important so that a buyer shouldnt take advantage from this situation and by from a cheaper price from one market and sell it to other market at a higher price. This is the second important necessary condition to practice price discrimination(Colander, 2014). Moreover, price discrimination occurs when the two sub markets are geographically distant from each other so that it becomes an expensive venture for the people who would intend to take advantage of the price differentials. This geographical distance would make it expensive to transfer goods from cheaper market to the dearer market. Price discrimination can also take place due to preferences or prejudices of the buyers. The same good is generally converted into two different varieties where the one has a superior packaging, designing, marketing strategy than the other one, thereby attracting people who could afford to purchase the superior packaging of the same product. Lastly, price discrimination is also possible when the buyers are not aware of the price differential of the same product being sold at the different market. It is possible when buyers are either ignorant or lazy of the difference in the price of the same product being sold at the different markets (Mankiw, 2007). A monopolist needs to decide what should be the total output and how much of the total output needs to be divided between the two markets as well as what should be the prices that will be charged. c). It is quite likely that the supplier would try to maximize the producer surplus by extracting consumer surplus thereby leading to the reduction in the overall social welfare. Moreover, this also includes high administrative costs and predatory pricing which may serve as a constraint to the supplier (Pindyck and Rubinfeld, 2004). 2) A surgeon charges different fee from the different sections of society. A surgeons service is unique. It cannot be transferred from one place to another. No buyer would be able to make advantage of the differential price charged by the surgeon. A surgeon charges higher fee from rich people and low fee from the poor people. This way, he separates his market ( the demand for his services) into two sub markets or sub sections of the society- rich and poor. Rich people depict that class of consumer whose demand for the surgeons services is relatively inelastic. Poor people depict that section of the society where the demand for his/her service is relatively elastic. When these two demands are combined , we get a combined demand for his services with a kink as marginal revenue must be same for both markets. Hence, a surgeon would charge a fee at a point where MR is positive and it lands at a elastic portion of the demand curve. Like mentioned above, a surgeon could practice price discrimination only if no patient takes advantage of the differential price. That is, no rich person would be treated at a lower cost and no poor people must pay higher fees. Moreover, a surgeon can provide same service in a local hospital where poor people would be treated as well as same services can be provided in a private hospital. Lastly, no patient should be able to take advantage of this price differences (Varian, 2010). References Bernheim , D Whinston, M 2009,Microeconomics, Tata McGraw-Hill (India), 2009. Colander , D 2014, Principle of Microeconomics, 9th edition, Mc Graw Hill Case, K Ray, C 2007,Principles of Economics, 8th edition,Pearson Education, Inc. Mankiw , G 2007,Economics: Principles and Applications, 4th edition South Western, Cengage Learning India Private Limited. Parkin, M 2013,Microeconomics, 11thedition, Prentice Hall. Pindyck, RS Rubinfeld D. 2006.Microeconomics, 6thedition,Prentice Hall. Varian, H 2010,Intermediate Microeconomics: A Modern Approach, 8th edition, W.W. Norton and Company.