Price Discrimination Price discrimination is the practice of selling different units of a good or service for different prices. To be able to price discriminate, a monopoly must: Identify and separate different buyer types Sell a product that cannot be resold Price differences that arise from cost differences are not price discrimination. Price discrimination may not be fair, but it is efficient Be sure that the students understand that aside from equity considerations, resources will be allocated more efficiently in a monopoly market under any price discrimination scenario than under a single-price scenario.

Price Discrimination Price Discrimination and Consumer Surplus Price discrimination converts consumer surplus into economic profit. A monopoly can discriminate Among units of a good. Quantity discounts are an example. (But quantity discounts that reflect lower costs at higher volumes are not price discrimination.) Among groups of buyers. (Advance purchase and other restrictions on airline tickets are an example.)

Price Discrimination Profiting by Price Discriminating Figures 12.8 and 12.9 show the same market with a single price and price discrimination and show how price discrimination converts consumer surplus into economic profit.

Price Discrimination As a single-price monopolist, this firm maximized profit by producing 8 units, where MR = MC and selling them for $1,200 each.

Price Discrimination By price discriminating, the firm can increase its profit. In doing so, it converts consumer surplus into economic profit.

Price Discrimination Perfect Price Discrimination Perfect price discrimination extracts the entire potential consumer surplus and converts it to economic profit.

Price Discrimination With perfect price discrimination: Output increases to the quantity at which price equals marginal cost. Economic profit increases above that earned by a single-price monopoly. Deadweight loss is eliminated.

Price Discrimination Efficiency and Rent Seeking with Price Discrimination The more perfectly a monopoly can price discriminate, the closer its output gets to the competitive output (P = MC) and the more efficient is the outcome. But this outcome differs from the outcome of perfect competition in two ways: The monopoly captures the entire consumer surplus. The increase in economic profit attracts even more rent-seeking activity that leads to an inefficient use of resources.

Monopoly Policy Issues Gains from Monopoly A single-price monopoly creates inefficiency and price discriminating monopoly captures consumer surplus and converts it into producer surplus and economic profit. And monopoly encourages rent-seeking, which wastes resources. But monopoly brings benefits. A quick introduction The treatment of monopoly policy here is brief and designed for the instructor who wants to cover the topic briefly and at this point in the course. Chapter 17 provides a more extensive treatment of regulation and antitrust law. You can cover that chapter, in whole or part, right now if you want to do more on the topic.

Monopoly Policy Issues Product innovation Patents and copyrights provide protection from competition and let the monopoly enjoy the profits stemming from innovation for a longer period of time. Economies of scale and scope Where economies of scale or scope exist, a monopoly can produce at a lower average total cost than a large number of competitive firms could achieve.

Monopoly Policy Issues Regulating Natural Monopoly When demand and cost conditions create natural monopoly, government agencies regulate the monopoly. Figure 12.11 shows how a natural monopoly might be regulated.

Monopoly Policy Issues With no regulation, the monopoly maximizes profit. It produces the quantity at which marginal revenue equals marginal cost.

Monopoly Policy Issues Regulating a natural monopoly in the public interest sets output where MB = MC and the price equal to marginal cost. This regulation is the marginal cost pricing rule, and it results in an efficient use of resources.

Monopoly Policy Issues With price equal to marginal cost, ATC exceeds price and the monopoly incurs an economic loss. If the monopoly receives a subsidy to cover its loss, taxes must be imposed on other economic activity, which create deadweight loss.

Monopoly Policy Issues Where possible, a regulated natural monopoly might be permitted to price discriminate to cover the loss from marginal cost pricing. Another alternative is to produce the quantity at which price equals average total cost and to set the price equal to average total cost—the average cost pricing rule.