Explain how a monopolist can use price discrimination to transfer part or all of
ID: 1218663 • Letter: E
Question
Explain how a monopolist can use price discrimination to transfer part or all of total economic surplus to itself. LO7 Explain how a monopolist that practices price discrimination can produce a larger economic surplus than a monopolist that charges one price to all buyers. LO7 True or false: Because a natural monopolist charges a price greater than marginal cost, it necessarily earns a positive economic profit. LO3, LO8 Explain why monopolistic competition produces a smaller economic surplus than perfect competition. Is your answer affected when you consider the variety of products offered by monopolistic competitors? Why? LO1Explanation / Answer
Question 6:
Price discrimination is a practice where different prices are charged to different customers. Suppose a customer is ready to pay $10 for a product. Monopolist has charged $4 for each unit sold. Here $10 can be stated as satisfaction received by the customer from that unit. According to Marshall, satisfaction received by a customer is the number of units he is ready to pay for it. So customer by spending $4 is getting satisfaction of $10. Thus excess $6 is consumer’s surplus. It is a part of the economic surplus enjoyed by customer. When this amount will be transferred to a producer, it will be termed as producer’s surplus, because producer is now getting more than the price at which he was ready to supply the product.
Now suppose monopolist has decided to discriminate and charge $6 to the customer instead of $4 charged to others. As a result, $6-$4=$2 now transferred from consumer to producer. Previously it was consumer’s surplus. Now due to discrimination, it has become producer’s surplus. This surplus will be reflected as addition in the economic profit of the monopolist.
From this analysis it can be rightly said that monopolist through price discrimination has transferred a part of economic surplus to itself.
Answer: 7:
Usually in price discrimination, market is divided into two or more segments with different price elasticity. Here elasticity is the degree of responsiveness of demand due to a certain change in price. As you know demand and price are inversely related. If demand responses less than price change, then elasticity value is less than 1. It is known as inelastic demand. In opposite situation, demand will change more than price. Elasticity will be greater than 1. It is known as elastic demand.
Suppose there is a rich market and poor market. Price discriminating monopolist will charge high price in rich market and low price in poor market.
Rich market has inelastic demand. If price is raised by one percent, then quantity demanded will decrease by less than 1%. (say 0.5%). Total revenue is the product of price (P) and quantity (Q). So before price change, total revenue was PQ. It was earned by a single price monopolist. After price change, TR will be (1.01P)(0.995Q)=1.00495PQ. It is higher than TR of single price monopolist. So discrimination will improve economic surplus earned from rich market.
Just opposite will happen in poor market. Here due to elastic demand, 1% lowering of price will increase demand more than 1%. Say demand has moved up by 2%. As a result, TR after discrimination is (0.99P)(1.02Q)=1.0098PQ. So TR again has increased due to discrimination.
From above analysis, it can be concluded that price discrimination can produce larger economic surplus than a monopolist that charges one price to all buyers.
Answer 8:
Economic profit is the excess of average revenue (AR) over average cost (AC). Here AR is price. AC includes normal profit as cost of organization. So AR>AC will mean, there is economic profit.
Objective of a monopolist is to maximize profit. It occurs when MC=MR. In diagram, it is observed, when MC curve intersects MR from below. Monopolist has to face a downward sloping AR or demand curve. If AR has negative slope, then MR curve will also have negative slope and it will be below AR curve. As MC=MR, so AR=P>MC. Usually under this situation some economic profit is earned. But it may not happen. MC curve has positive slope. So MR will be higher than MC. If at MC=MR, AC and AR are found equal, then only normal profit is earned.
In diagram above, AR=AC at equilibrium quatty qe.So no economic profit is earned.
Thus statement of the problem is not always true.
Answer 9:
In perfect competition, due to many buyers and sellers, homogeneous product and free entry/exit no one can influence the price. Here equilibrium price is determined by the interaction of market demand and supply. Price is static. At this price any quantity can be sold. So at equilibrium MC=MR=AR. Due to this reason much higher quantities are sold at a low price. So economic surplus in perfect competition will be much higher than it is observed in monopoly.
When many products are sold by moopolist, the market becomes close to competition, As buyers are many. Also choice of product are many. So situation will definitely improve.
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