Monopoly, Non-Linear Pricing as Well

¶ … monopoly, non-linear pricing as well as the imperfect information in the insurance markets (Stiglitz,1977).Most of the paper is dedicated to the investigation of the behavior of an insurance market with monopolistic tendencies. The importance of this question and example is to due to the behavior of the competitive nature of analogue market having imperfect information. The information gathered and any finding and conclusions are to be used in providing information for the insurance industry.

In any competitive market, there is never any kind of planning in regard to the kinds of contracts that are offered so as to ensure that the data and information which is made available to the general public (such as the relative probability of accidents) in an effective manner. An open, free and non-monopolistic system allows for the free sharing of information on the probabilities of accidents. In a monopolistic insurance industry, the whole set of contracts are solely decided upon by the insurer. The fact that the monopolists' are far too high seems to suggest that;

The whole set of insurance policy prices that are available will greatly differ in regard to the two equilibriums.

There is a difference in the basis of discrimination. This is to say that in competition, the only difference lies in the level of risk such as the probabilities of accidents, a fact which acts a motivation for differentiation. In a monopolistic environment, anything which results in a difference in the demand curves such as differences in the levels of risk aversion and the differences in the level of risks provide a perfect basis of differentiation. In this paper, we consider the problems created by monopoly as well as the concept of price differentiation within the insurance industry. The theory which we relate to in the process is the theory of optimal taxation.

The monopolist insurance provide would be very much interested to distinguish among the various individuals so as to allow him a chance of charging different prices. In a normal optimal tax system, the government usually distinguishes among individuals so as to tax them in accordance to their personal "ability to pay" (Stiglitz,1977,p.).

If the government had adequate data and information on the individuals, it would charge them a lump sum tax that is based on their level of income. The amount of income eraned is therefore used as a screening device. Other types of screening devices exist. Should there be a large difference in regard to the their attitudes to the consumption of leisure products and services, then income may never be the best screening device. This paper focused only on a limited set of screening devices that may be employed by monopolists as well as the quantity of the different commodities that may be purchased.

2. The method used to answer the question

Theory

Theoretical framework is important for the study of various disciplines (Abraham,2008).This is because theory can act as a guide for the processes of research, curriculum development, practices as well as the development of various strategies.

The theoretical model for the Stiglitz (1977) paper is based on the conventional theory of monopoly. It is common knowledge that monopolists will tend to increase the level of their profitability by engaging in a deliberate process of price discrimination.

The feasibility of price discrimination as well as its desirability is depended on the satisfaction of two conditions. These conditions include;

The ability of the firm to identify at least two or more groups having different functions of demand (or demand functions).

There must be an impossibility of the price being equalized by an arbitrageur

The conventional theory has kind of focused on price discrimination on the basis of two extreme localities or rather countries for which the aspects of elasticity of demand differ as well as the cost of transport. These two variables are sufficiently large as to prevent any form of price equalization.

Stiglitz (1977) noted that the conventional theory of monopoly has in a way been restrictive in an unnecessary manner in regard to two main aspects. The first aspect is that the monopolists will generally tend to charge their clients amounts that are proportional to the quantity that they consume (This is referred to by Stiglitz (1977) as the liner price schedule).Such a policy is noted by Stiglitz (1977) to never lead to profit maximization. The non-liner price schedules are noted to be desirable when feasible. Monopolists are however noted to introduce various forms of inefficiencies due to factors such as secondary resale markets or sue to the fact that individuals differ. These are noted as the discriminating aspects of monopolists in the insurance sector. The second aspects of the conventional theory of monopoly in regard to the insurance industry is that it assumes that all of the firms have a much more constricted and limited ability to effectively differentiate as well as discriminate among its clients, a proposition which is true in actual practice. Location is noted as a basis of differentiation. The quantity consumed is also used a basis of differentiation and hence screening. This is because the quantity that is consumed is usually correlated with the level of consumer surplus. All these are examples of screening devices. A screening device is defined by Stiglitz (1977,p.408) as any mechanism which is employed by firms to differentiate among its clients. Screening devices are therefore a basis of differentiation that is used a selection mechanism on the basis of an individual's actions such as their choice of insurance policy.

Empirical underpinnings

The work is based on a series of empirical formula. The one that is used is the general formulation of monopoly-price discrimination.