Price Discrimination and Monopoly

A discriminating monopoly is an entity charging different prices for its services or products in different markets or consumers. The prices are usually not associated with the cost of the product or service provision. A company operating as a discriminating monopoly using its position in market control has the leverage of doing this by provided there are variations in the price elasticity of demand markets or consumers and barriers, thereby preventing consumers or customers from attaining arbitrage profitability by selling the products or services amongst themselves. Therefore, by ensuring that every consumer need is catered for, the monopoly, in turn, achieves maximum profitability (Brickley, Smith & Zimmerman, 2015).

Usually, when there are two or more market segments, and each experiences a difference in the price of the product or service charged by the monopolist, the monopolist must equate the marginal revenue with the marginal cost of each market segment. Marginal cost refers to the change in the total change in a product's production cost that results from the production of an additional unit. It is calculated by obtaining the change in production cost, divided by the change in quantity. If the marginal cost of the production of the extra unit is lower than the per-unit price, then there is a potential for making profits. Marginal revenue, on the other hand, describes the total revenue generated by the extra unit produced.

Discriminating monopolies operate in a variety of ways and are influenced by certain factors. For instance, the different prices of products and services can be established based on factors including the location and demographics of the firm's customer or consumer base. For example, the price of a product in a rich environment will potentially be higher than the price of the same product in an environment with lower-income consumers. Other factors affecting monopolists' product and service pricing also include holidays and major sporting events. This is because such events come with an increased demand for products due to the increased visitor influx.

Therefore, by targeting every consumer, the monopolist can make higher economic profits. Hence, price discrimination can only be achieved through the status of a monopolist firm to control production and pricing without competition. The main advantage associated with the price discriminating monopoly is that it increases the chance of maximizing profits. This happens when the monopolist charges different prices to different consumers in the different market segments. Sometimes it makes sense to charge lower prices to some consumers, provided that the price remains greater than the marginal cost.

This meets the condition for allocative efficiency in microeconomics; that is, a product should be produced if its price covers its marginal cost. A price discriminating monopoly will have allocative efficiency since the price of the last unit sold will equal the marginal cost. Moreover, provided the marginal cost stays positive, the total cost will increase (Brickley, Smith & Zimmerman, 2015). Unlike the pure competition, monopolists tend to charge their consumers more than the average and marginal production and distribution costs. This makes the monopolistic organization or firm earn more profits. Compared to competitive industries, monopolies restrict output.

Price discrimination by monopolies can also be looked at from the perspective of heterogeneous consumer demands. Consumers often vary in their willingness to pay for products. With a heterogeneous consumer base, the monopolist makes even higher profits than a homogenous base by charging different prices of products and services based on the consumers' willingness to pay. Therefore, price discrimination only occurs on this basis and is not dependent on the differences in production and distribution costs (Brickley, Smith & Zimmerman, 2015). With price discrimination, the profit margin or markup realized is different across various consumers. Two conditions must be present for the firm to realize maximum profits from price discrimination.

The first is that there has to be a variation in the consumers' willingness to pay, commonly known as heterogeneous market demands. Failure to meet this condition eliminates the need for market segmentation in the first place. The second condition is that the monopolist firm must identify any sub-market since this will help restrict transfers among consumers across the different submarkets. If this condition is not met, any attempt to charge differential prices might be undercut by the resale occurring across the different submarkets. This might happen when some consumers purchase the products at lower prices and then resale at prices below those predetermined by the firm.

Demand Curves for Market Segments A and B

The figures above illustrate the output and the price decisions of the monopolistic firm under consideration which has two separate markets, A and B, where each market has a different demand curve. In the second curve representing market A, demand is represented by P=18-2Q for the favorable prices and quantities. The marginal costs, in this case, are $4. The profit-maximizing output will occur from the diagram generated at six units where the marginal revenue equals the marginal cost (MR=MC). To sell this firm's output, it charges a price of 6. From these statistics, this firm is going to make a $2 per unit profit. This is obtained by subtracting the marginal cost from the charged price ($6 -$4). Further calculations will result in a total profit of $36, obtained by multiplying the profits per unit (6 by 6). The rectangular part of the curve illustrates this.

The first curve represents the second market, market B. here, the demand curve is represented by the equation P=9-Q for the favorable prices and quantities. The marginal costs remain the same as the average total cost, which is equal to $4. Therefore, the profit-maximizing output from the curve is generated at three units, where the marginal revenue is equal to the marginal cost. For this firm to sell its output, it has to charge the price of $12. From the above values, this firm should make about $8 per unit profit. This is obtained by subtracting the marginal cost, which is $4, from the firm's price ($12-$4). To obtain the total profits generated by the sales, the profits per unit will be multiplied, as indicated by the rectangular part of the curve for the market segment B, which is $64.