Q29 — Price Discrimination & Equilibrium of a Discriminating Monopolist

Introduction

In the standard theory of monopoly, the monopolist normally charges one uniform price for all units of his product. In reality, however, many monopolists and dominant firms charge different prices for the same commodity from different customers or in different markets. This practice is known as price discrimination and constitutes one of the most important applications of monopoly theory in the Panjab University B.Com (Sem I) syllabus, as presented in “Microeconomics” by T.R. Jain & V.K. Ohri.

In this answer we shall: (i) define price discrimination; (ii) state and explain the conditions under which price discrimination is possible and profitable; and (iii) discuss price and output determination by a discriminating monopolist with the help of a clear three-panel diagram and logical explanation.

I. Meaning and Types of Price Discrimination

1. Meaning of Price Discrimination

When a monopolist (or a seller with market power) charges different prices for the same commodity or service to different buyers, without corresponding difference in cost of supply, he is said to practise price discrimination.

Definition (exam-style):
Price discrimination is the practice of selling the same commodity at different prices to different buyers or in different markets, not justified by differences in the cost of supplying the product, but based on differences in demand elasticity or ability to pay.

2. Examples (for conceptual clarity)

Different railway fares for first class, second class and sleeper class passengers.
Higher charges for electricity used for commercial purposes than for domestic use.
Student concessions and senior citizen concessions in transport and cinema halls.
Doctor charging rich and poor patients different fees for the same treatment.

3. Degrees (Forms) of Price Discrimination (Pigou’s Classification)

A.W. Pigou distinguished three degrees (you may briefly mention them to enrich your answer):

First-degree (perfect) price discrimination: The monopolist charges each individual customer the maximum price he is willing to pay for each unit. He captures the entire consumer surplus. This is a theoretical extreme.
Second-degree price discrimination: Different prices are charged for different blocks of units or quantities, e.g. bulk discounts, block tariff for electricity, etc.
Third-degree price discrimination: Different prices are charged in different sub-markets segmented on the basis of elasticity of demand (e.g. domestic vs industrial users, local vs foreign market). This is the most important form and the main focus of this question.

II. Conditions for the Possibility of Price Discrimination

Price discrimination is not always possible. Certain necessary conditions must be satisfied for a monopolist to practise price discrimination successfully and profitably.

1. Monopoly Power or Market Control

The first essential condition is that the firm must possess some degree of monopoly power:

There must not be a large number of competitors selling close substitutes.
The firm should have control over the supply of the product or over a major part of the market.
In perfect competition, price discrimination is impossible because each firm is a price-taker.

2. Ability to Separate Markets

The monopolist must be able to divide the market into separate sub-markets (or groups of buyers) such that:

Each group or sub-market can be charged a different price.
Examples: geographical separation (domestic vs foreign market), customer categories (students, adults), type of use (industrial vs commercial vs domestic).

Without such segmentation, it is impossible to charge different prices to different buyers for the same product.

3. Differences in Elasticity of Demand between Markets

There must be a difference in price elasticity of demand in the different sub-markets:

In the market where demand is less elastic (|e| smaller), the monopolist charges a higher price.
In the market where demand is more elastic (|e| larger), the monopolist charges a lower price.
If elasticity were the same in all markets, price discrimination would not increase profit as compared with a uniform price.

4. Prevention of Resale (No Arbitrage)

Another essential condition is that buyers who buy at a low price in one market should not be able to resell the product easily to buyers in the high-price market. Otherwise:

Price differences between markets would break down.
Arbitrageurs would buy in the cheaper market and sell in the costlier market until prices equalise.

Therefore, the monopolist must be able to prevent resale by using legal, technical or physical barriers (e.g. non-transferable tickets, personal services, geographically separated markets).

5. Ignorance of Buyers or Imperfect Information

Sometimes price discrimination is facilitated by ignorance of consumers about prices charged to other buyers, or by the difficulty of comparing prices. If buyers know each other’s prices perfectly, discriminatory pricing may be resisted.

6. Legal and Institutional Possibility

In some cases, legal restrictions may prevent certain forms of discrimination (e.g. anti-trust laws). Price discrimination can be practised only when it is not prohibited by law and is institutionally feasible (for example, railway tariffs fixed by the government often explicitly allow differential pricing by class).

Summary of Conditions for Price Discrimination

Existence of monopoly power or at least market dominance.
Ability to divide the market into separate sub-markets or groups of buyers.
Different price elasticities of demand in different markets.
Prevention of resale between markets (no arbitrage).
Sufficient ignorance or acceptance of price differences by consumers.
Legal and institutional possibility of differential pricing.

III. Price and Output Determination by a Discriminating Monopolist (Third-Degree)

We now explain how a discriminating monopolist determines his total output and the prices in different markets, assuming third-degree price discrimination between two markets, say Market A and Market B, with different elasticities of demand.

1. Basic Assumptions

The monopolist sells the same product in two distinct markets, A and B.
Demand in Market A is relatively less elastic; demand in Market B is relatively more elastic.
The monopolist’s total cost depends on the total output supplied to both markets together.
He can separate the two markets and prevent resale between them.

2. Step-wise Procedure for Equilibrium

The discriminating monopolist chooses output and prices in two steps:

Step 1: Determination of total output (Q) for the two markets taken together.
For this, the monopolist constructs a combined marginal revenue curve (MR_T) by horizontally summing the individual MR curves of the two markets (MR_A and MR_B). He then equates this combined MR_T to his marginal cost (MC) curve for total output:
MR_T = MC
This determines the profit-maximising total output Q*.
Step 2: Allocation of total output between the two markets and determination of prices.
The total output Q* is then divided between Market A and Market B such that:
MR_A = MR_B = MC
That is, the monopolist sells Q_A units in Market A and Q_B units in Market B, where Q_A + Q_B = Q* and marginal revenue in each market is equal to the common marginal cost. The different prices in the two markets are then read off from the respective AR (demand) curves: P_A from AR_A at Q_A and P_B from AR_B at Q_B.

Important: Since demand in Market A is less elastic, P_A will be higher. Since demand in Market B is more elastic, P_B will be lower. Thus, “higher price in inelastic market and lower price in elastic market” is the core principle of profitable price discrimination.

IV. Diagram: Price and Output under Third-degree Price Discrimination

Fig. — Third-degree price discrimination: Market A (less elastic) is charged higher price Pₐ for quantity Qₐ; Market B (more elastic) is charged lower price P_b for quantity Q_b. Total output Q* is determined where combined MR (MR_T) equals MC. Allocation is such that MRₐ = MR_b = MC.

5. Key Properties of Discriminating Monopoly Equilibrium

Total output Q* is the same as if the monopolist were selling in a single market with MR_T.
Output is distributed between markets so that MR is equalised across them: MR_A = MR_B = MC.
Price is higher in the market with less elastic demand and lower where demand is more elastic: P_A > P_B.
Total profit under discrimination is greater than under a uniform price policy (otherwise, the monopolist would not practise discrimination).

Illustrative statement: The discriminating monopolist equates marginal revenue in each sub-market to a common marginal cost and charges higher price in the inelastic market and lower price in the elastic market, thereby securing higher total profit than under a uniform price.

V. Price Discrimination: Desirability and Effects (Brief Discussion)

While the question mainly asks for definition, conditions and equilibrium, a brief discussion of merits and demerits of price discrimination enhances your answer and shows maturity of understanding.

1. Possible Advantages

Greater output and utilisation of capacity: By charging lower prices in more elastic markets, the monopolist can sell more units and operate at a higher level of output, sometimes closer to efficient capacity.
Beneficial services: Price discrimination may make socially useful services (e.g. railways, electricity, education) economically viable by allowing high-paying users to cross-subsidise low-paying groups.
International competitiveness: Lower prices in foreign markets can help a firm compete internationally, while higher prices in domestic markets recover fixed costs.

2. Possible Disadvantages

Exploitation of consumers: In inelastic markets, consumers may be charged very high prices because of lack of substitutes.
Misallocation of resources: Since price is not equal to MC in each market, price discrimination may lead to allocative inefficiency.
Equity issues: Some forms of price discrimination may be regarded as unfair or discriminatory, especially when based on arbitrary classifications.

Exam Tip (for full 15 marks): Structure your answer as follows: (i) formal definition with 1–2 concrete examples; (ii) brief classification of degrees of price discrimination (first, second, third degree) with focus on third degree; (iii) clearly listed conditions for price discrimination (monopoly power, market separation, different elasticities, no resale, etc.); (iv) detailed explanation of price and output determination by a discriminating monopolist—two-step procedure, combined MR_T, MRₐ = MR_b = MC, and “higher price where demand is less elastic”; and (v) neat three-panel diagram with proper labelling. End with 3–4 lines of evaluation or effects. This pattern is fully consistent with T.R. Jain & V.K. Ohri and is highly appreciated by Panjab University examiners.

Conclusion

To conclude, price discrimination is a typical feature of monopoly power, whereby the monopolist charges different prices for the same product in different markets or from different groups of buyers, not justified by cost differences but by differences in demand elasticity and ability to pay. It is possible only under certain conditions—existence of monopoly power, separable markets, different elasticities and prevention of resale. Under third-degree price discrimination, the discriminating monopolist first chooses total output by equating combined marginal revenue (MR_T) to marginal cost (MC), and then allocates output between markets so that MR is equal in each market and equal to MC, charging higher price in the inelastic market and lower price in the elastic one. This yields greater total profit than uniform pricing and represents the standard textbook analysis prescribed for B.Com (Sem I), Panjab University.

These notes form part of a carefully curated set of important questions which have frequently appeared in past university examinations and therefore carry a high probability of being reflected, in whole or in part, in future question papers. However, they are intended as high-quality academic support material only and should not be treated as a guarantee or assurance of any specific questions being asked in forthcoming exams.