Elaborate On What Is Required Before A Firm Can Perfectly Price Discriminate

The Management Environment - BM101

"Elaborate on what is required before a firm can perfectly Price Discriminate."

The following assignment will comprise of information based on the article by Geoff Stewart, 2003 and will attempt to examine the different factors that are required before a firm can set prices in a discriminatory fashion. Business firms may find that by charging different customers different prices for a common product may actually increase the profits of the firm. This charging of different prices for a particular good is known as Price Discrimination (Britton, 2003) and is very common in various monopolistic markets. The article by Stewart, (2003) uses the concept of student discounts as an example of price discrimination. This is where they are given the advantage of buying various goods or services at a discounted rate due to their lower willingness to pay because of their income and also their position in the market. The essay will aim to identify why price discrimination occurs, why it exists for some items but not others, and whether it results to an increase or reduction in economic welfare.

According to Stewart, (2003) there are three main factors that a firm needs to consider before it can use price discrimination: They must have market power and usually be a monopolist because if there was high competition with other firms, the consumer would simply choose a rival product at a cheaper price which would defeat the object of using price discrimination to maximise profits because the sales would fall. The firm therefore requires power over price and consequently price discrimination is not possible in a perfectly competitive environment. Secondly, a firm would need to obtain information on the willingness of specific customers to pay for the same product. However, it is unlikely that a firm would be able to achieve this precisely and therefore would rely upon the demand of certain 'groups' within the market which are identified by their elasticity of demand (Atkinson and Miller, 1998) to differentiate between consumers and their willingness to pay. This is one reason why a firm is unable to 'perfectly price discriminate' and leads on to why multi-market price discrimination is more appropriate which will be discussed later in the essay. Lastly, it is important for there to be some sort of constraint on the resale of the product by the consumer because someone who was

charged a lower price could re-sell the product on a higher price and would consequently undermine the profits made. Some products listed by Stewart, (2003) are ruled out from resale due to the fundamental nature of the product such a haircut or meal, but other products that are not need to have restrictions made by the firm.

Table 1 - Willingness to pay

Individual 1 Individual 2 Individual 3

Students 5 4 3

Teachers 9 4 1

According to Figure 1 in the Stewart (2003) article (shown above), if the firm used uniform pricing, the profit-maximising point would be 'pm' which is related to the output 'Qm' and would therefore generate a profit equal to the area 'vxyw' which equates to the total amount of producer surplus earned. Producer surplus is defined by Stewart, (2003:1) as:

"The difference between the actual price of a good and the minimum amount at which a firm would be willing to supply it."

The marginal cost is represented by the line MC on figure 1 of Stewart's article which is also the same as the average cost. This is defined by Stewart, (2003:1) as:

"The minimum price at which a firm will supply an additional unit of a good."

Point 'Y' on the graph displays the 'break even' point where total revenue is equal to total cost and therefore if the product is sold at a price below this, the firm would be making a loss because the production cost is greater than the selling price which is not feasible.

Competition from other firms force the price of products down from 'pm' to 'pc', which is likely to increase demand from 'x' to 'z' and therefore the output would need to increase from 'Qm' to 'Qc' in relation to this (figure 1 of the Stewart article). The products are therefore sold at a lower price but with increased sales to fit in with the competitors depending on the elasticity of demand and the response of a change in price of the product.

However, if a firm considered the above factors, they could engage in price discrimination as a tool to maximise profits. Once a firm has established the elasticity of demand from the groups of consumers, it needs to extract consumer surplus by varying the price which will lead to additional revenue and profit. Consumer surplus is defined by Stewart, (2003:1) as:

"The difference between the maximum amount an individual is prepared to pay for a good and the actual price."

The