Question

True or False (a) In a monopoly market, the social welfare is always lower than in a competitive market. (b) Price discrimination is likely to be most effective when the good being sold is a standardized commodity. (c) A firm charges different prices to customers buying different quantities. This is an example of third-degree price discrimination.

Short answer

(a) True, (b) False, (c) False.

Step-by-step solution

Understanding Monopolies and Social Welfare

In a monopoly market, a single firm dominates the supply without direct competition. This often leads to higher prices and lower output compared to a perfectly competitive market, where many firms strive to offer competitive prices and maximize consumer surplus and social welfare. Therefore, the social welfare in a monopoly is typically lower due to decreased consumer and producer surplus.

Defining Price Discrimination and Commodities

Price discrimination involves selling the same product at different prices based on factors like consumer segments or purchase quantities. It's most effective with differentiated products where sellers can leverage varying consumer willingness to pay. Commodities are often uniform products with limited branding, making effective price discrimination harder because differentiation and varied willingness to pay are limited.

Identifying Types of Price Discrimination

Third-degree price discrimination involves charging different prices to different segments of consumers—often based on observable characteristics like age or location. However, charging different prices based on purchase quantity is typically an example of second-degree price discrimination, where prices vary depending on the amount purchased, such as bulk discounts.

Key concepts

Social Welfare in Monopoly vs. Competitive Markets

Social welfare refers to the overall well-being of society in terms of economic efficiency and distribution of resources. In a competitive market, many firms compete to offer the best prices and quality. This leads to optimal resource allocation, maximizing consumer and producer surplus.

On the other hand, a monopoly market is characterized by a single firm that controls the entire supply of a product or service. Because of this control, the monopolist can set higher prices and produce less than what would be produced in a competitive market.

• Higher prices lead to lower consumption, reducing consumer surplus.
• Producer surplus may increase, but not enough to offset the loss in consumer surplus.

Therefore, social welfare generally decreases in a monopoly relative to a competitive market, as the total surplus—consisting of both consumer and producer surplus—is not maximized.

Understanding Price Discrimination

Price discrimination occurs when a firm sells the same product at different prices to different consumers. To successfully implement price discrimination, firms must have the power to set prices and separate markets with different demand elasticities.

Price discrimination is most effective with goods that are not standardized commodities. Commodities are uniform, meaning they have little room for differentiation.

• Standardized commodities have similar prices and features across different suppliers.
• Without differentiation, it's hard to justify varying price points.

In contrast, differentiated products allow firms to cater to different consumer segments and adjust prices based on willingness to pay. This allows businesses to extract more consumer surplus and increase their profits.

Types of Price Discrimination in Market Structures

Price discrimination can take various forms, depending on how prices are set for different consumer groups.

One common form is third-degree price discrimination, where firms charge different prices based on observable consumer characteristics such as age, location, or time of purchase. This is not to be confused with second-degree price discrimination, which depends on the quantity purchased—often seen in bulk buying discounts.

• Third-degree targets consumer groups with different demands.
• Second-degree incentivizes consumers to purchase larger quantities.

Understanding these distinctions helps explain how firms maximize profits while operating in different market structures. Each form of price discrimination requires the company to strategically analyze its market and consumer behavior to optimize revenue.