Price Discrimination, Welfare and Efficiency Exam Answer

To what extent does price discrimination lead to an improvement in economic welfare and efficiency?

Firstly, price discrimination may have many beneficial progressive effects to society as a whole. This could be seen as poorer families have lower incomes and therefore cannot afford to potentially pay the normal market price. Therefore price discrimination allowing them to pay cheaper prices could have many beneficial effects. It could increase their standards of livings as it enables them to purchase more and a greater diversity of goods.

For example, OAPs and students are given discounts in various goods and services for examples rail travel. Students and people over 65 both receive 25% all tickets, a significant discount. This is very beneficial as it provides greater support to the poorer part of the population. Furthermore this positive effect could be seen in education as the less wealthy part of the population can be given scholarships and bursaries, allowing them greater educational possibilities. This progressive effect has a positive effect to economic welfare.

However, despite the apparent positive effect to society, the system of price discrimination is allocatively inefficient. The majority of consumers exposed to price discrimination pay a price well above the marginal cost. There are many forms of price discrimination where the poor are in fact disadvantaged for example with greater prices for basic products at motorway service stations. This price discrimination is harmful to low income people. Furthermore, with price discrimination, it may be unfair as people on higher incomes or people not entitled to the cheaper prices may feel that it is inequitable. These people may feel that they are unfairly paying higher prices simply because they can afford to. This may have a negative effect on economic welfare.

Price discrimination is utilised by firms to receive a larger amount of profit, as long as the marginal revenue is greater than the marginal cost. Therefore the greater profit that is received through price discrimination could be used to increase dynamic efficiency. BT has announced a £1.5 billion investment providing ‘super-fast broadband to as many as 10 million homes by 2012’. This investment has been made possible through the price discrimination BT uses such as family/business packages. Furthermore, this reinvestment allows the companies to progress and achieve further profit, a self-reciprocating circle of growth. This is clearly depicted through the example of an independent art gallery that is funded through payment upon leaving. The profit produced funds further investment into better art which then provides greater profit.

However, those who pay lower prices may be able to afford higher prices, for example many of the people who qualify for over 65 discounts may be the richest parts of the income distribution. This may be a limitation of price discrimination. Price discrimination may also be seen to be manipulative of those with inelastic demand. This can be seen with prices of snow shovels increasing at most hardware stores in America recently due to the snow storms. This price rise may be seen to take advantage of those who have to buy the good but may it may not be affordable. Furthermore the price may be unethical for example the price difference of an identical nurofen product.

The use of price discrimination may have other benefits to a firm for example allowing it to create economies of scale. Price discrimination allows a firm to sell at a much higher output.

Therefore it is making use of its previous spare capacity. This allows the firm to be more efficient with its factors of production. The increased output allows the firm to have lower long run average costs, further achieving greater profits. Spare capacity for a firm is an inefficient use of resources and therefore reducing spare capacity is key for a firm. Increasing output allows the firm to be productively efficient, selling the most goods and services as possible. This could be seen in Costco through bulk buying and specialised discounts for individuals it is able to use up all spare capacity selling the greatest amount possible.

The use of price discrimination can be seen to reinforce the power that monopolies weald. The circle of growth through price discrimination allows monopolies to grow and gain more of the market share. This could be a problem for consumers later on as monopolies may unanimously increase prices. The growth of monopolies may act as a barrier to market entry for small firms. This may limit the level of consumer choice and reduce social welfare. For example the price discrimination has allowed large cinemas such as Vue and Odeon to monopolise the market. This limits the entry ability for small cinemas who cannot compete with the economies of scale.

One possible social welfare benefit of price discrimination is the environmental spillovers. The use of price discrimination can allow firms to use up spare capacity which could reduce the level of waste. This can be seen in supermarkets where price discrimination allows them to sell more goods, reducing the amount thrown away. Furthermore, price discrimination can be used to promote renewable energy generating larger profits. The use of price discrimination can allow previously unprofitable start-up companies to stay in business. This has economic benefits and social benefits as pollution decreases and unclean, non-renewable energy declines.

Despite this, the use of price discrimination may lead to shadow markets forming. For example price discrimination in the gaming industry leads to the growth of second hand stores growing. This has been shown through the recent growth of CEXchange, a second-hand tech shop. This secondary market may cut into the profits of firms. There has been growth in businesses such as stubhub reselling tickets to events such as festivals, gigs and sports events. The profitability of firms is reduced when the goods are bought for cheap prices and sold elsewhere at a higher price, creating profit for the resale business.