9.7 : Price Discrimination under Monopoly

Price discrimination under monopoly refers to the practice where a monopolist charges different prices for the same product or service to different customers or in different markets. This strategy allows the monopolist to capture more consumer surplus, turning it into additional profits. For price discrimination to be effective, three conditions must be met: 1) the firm must have market power, 2) the firm must have the ability to separate markets or customers, and 3) the firm faces different price elasticities of demand among the customer groups.

There are three degrees of price discrimination. First-degree (or perfect) price discrimination involves charging customers the maximum they will pay for each unit, capturing all available consumer surplus. This requires that the firm have detailed knowledge of each customer's willingness to pay.

Second-degree price discrimination offers different prices based on the quantity consumed or the version of the product without knowing each customer's willingness to pay explicitly. Bulk buying discounts and premium versions of the same product are common examples. This type of discrimination relies on customers self-selecting into different price categories based on their preferences and consumption patterns.

Third-degree price discrimination involves segmenting consumers into different groups based on observable characteristics (age, location, time of purchase) and charging each group a different price. This method relies on general characteristics of the product to infer consumer willingness to pay. This is the most common form of price discrimination in practice.

Each degree of price discrimination allows the monopolist to increase profit by extracting more consumer surplus.