A2 Micro: Consequences of Price Discrimination

Who gains and who loses out from persistent and pervasive price targeting by businesses? To what extent does price discrimination help to achieve an efficient allocation of resources? There are many arguments on both sides of the coin – indeed the impact of price discrimination on welfare seems bound to be ambiguous.

Impact on consumer welfare

Consumer surplus is reduced in most cases - representing a loss of welfare. For the majority of buyers, the price charged is well above the marginal cost of supply.

However some consumers who can now buy the product at a lower price may benefit. Lower-income consumers may be “priced into the market” if the supplier is willing and able to charge them less. Good examples might include legal and medical services where charges are dependent on income levels.

Greater access to these services may yield external benefits (positive externalities) that then affect social welfare and equity. Drugs companies might justify selling their products at inflated prices in countries where incomes are higher because they can then sell the same drugs to patients in poorer countries.

Producer surplus and the use of profit

Price discrimination benefits businesses through higher profits. A discriminating monopoly is extracting consumer surplus and turning it into supernormal profit. Price discrimination also might be used as a predatory pricing tactic to harm competition at the supplier’s level and increase a firm’s market power.
A counter argument to this is that price discrimination might be a way of making a market more contestable. For example, the low cost airlines have been hugely successful by using price discrimination to fill their planes.

Profits made in one market may allow firms to cross-subsidise loss-making activities/services that have important social benefits. For example money made on commuter rail or bus services may allow transport companies to support loss-making rural or night-time services. Without the ability to price discriminate, these services may have to be withdrawn and jobs might suffer.

In many cases, aggressive price discrimination is a means of business survival during a recession. An increase in total output resulting from selling extra units at a lower price might help a monopoly to exploit economies of scale thereby reducing long run average costs.