Price discrimination is a practice used by monopolies in which specific products are sold to different buyers and each consumer is charged the highest price that they are willing and able to pay. The price they are charged is based on their purchasing power and their demand elasticity.
There are three conditions that need to be present in order for a monopoly to practice price discrimination:
- The firm must have monopoly power.
- The firm must be able to segregate the market.
- Consumers cannot easily re-sell the product in the market.
There are many differences between a regular monopoly and one that price discriminates. Take a look at the table below for more information.
When a monopoly price discriminates, it becomes allocatively efficient. A pure monopoly always produces less than a perfectly competitive market, meaning its level of output is not allocatively efficient. When a monopoly price discriminates, it earns a higher marginal revenue (MR), so it will increase its output and produce at the allocatively efficient level of output.
By price discriminating, a monopolistic firm will increase its economic profits. A pure monopoly charges a single price, where a price discriminator will charge each consumer at different prices. This eliminates consumer surplus and turns that into revenue, which in turn increases the economic profits that are earned by the firm.
Examples of various situations where monopolies are price discriminating include:
- An airline charging different prices to customers for the same flight. Many times the cost varies based on how much in advance the flight is booked (i.e. more expensive the closer you get to the actual flight) or based on your past ticket purchases.
- A university charging out of state tuition vs. in state tuition.
- A sports team charging different prices for seats in the same section of a stadium.
- A car dealership negotiating car prices with consumers on an individual basis.
- A movie theater charging different prices for tickets based on a consumers age.
Graph of a Price Discriminating Monopoly