Question

Suppose a monopolist discovers a way to perfectly price discriminate. What is consumer surplus under this scenario? What are the efficiency costs?

Short answer

Consumer surplus is 0, and there are no efficiency costs.

Step-by-step solution

Understanding Perfect Price Discrimination

Perfect price discrimination occurs when a monopolist charges each consumer exactly what they are willing to pay for each unit of the good. This means the monopolist can capture the entire consumer surplus, leaving no surplus for consumers.

Calculating Consumer Surplus

In a perfectly price-discriminated market, the monopolist charges each buyer their maximum willingness to pay, converting what would have been consumer surplus into additional revenue for the firm. As a result, consumer surplus is 0.

Assessing Efficiency Costs

With perfect price discrimination, the monopolist maximizes total output just like a perfectly competitive market, meaning there is no deadweight loss, and the outcome is allocatively efficient. Thus, while consumer surplus is zero, the market operates efficiently in terms of resource allocation.

Key concepts

Consumer Surplus

In economic terms, consumer surplus represents the difference between what consumers are willing and able to pay for a good or service versus what they actually do pay. It is essentially a measure of the economic benefit consumers receive from buying goods at a certain price.

When a monopolist practices perfect price discrimination, they charge each consumer exactly what they are willing to pay for each unit. This means that all consumer surplus is effectively absorbed by the monopolist as increased revenue. In this scenario, the consumer surplus is reduced to zero.

• Each consumer pays their maximum willingness to pay.
• All potential consumer surplus is captured by the monopolist.
• Consumers gain no surplus under perfect price discrimination.

Therefore, while consumers do receive the goods they value, they do not enjoy any surplus or economic benefit beyond the transaction.

Efficiency Costs

Efficiency in an economic context is often about how resources are allocated. In markets, efficiency costs can refer to losses in allocative or productive efficiency due to market structures or policies.

Under perfect price discrimination, although consumer surplus is zero, the market outcome achieves efficiency in allocation. This is because the monopolist can offer exactly the quantity of goods that would be sold in a perfectly competitive market. All units of the product are sold where the consumer's maximum willingness to pay meets the cost of production.

• Production meets the ideal output level without excess or shortage.
• The result is no deadweight loss, which minimizes efficiency costs.
• The allocation of resources aligns with consumer preferences.

While consumers might not enjoy surplus, the total welfare – the sum of consumer and producer surplus – is maximized, meaning resources are efficiently used.

Monopolist Behavior

A monopoly occurs when a single firm dominates the market for a particular good or service. This firm has significant control over prices and can influence market outcomes.

When a monopolist employs perfect price discrimination, its behavior diverges from that often expected in monopoly situations. Here, the monopolist can allocate goods efficiently, achieving the socially optimal level of output. However, while this seems advantageous efficiency-wise, it mainly benefits the monopolist at the expense of consumer surplus.

• The monopolist captures all potential consumer surplus.
• Output levels meet market quantity demanded without excess.
• Produces at a level resembling a competitive market, but without competitive pricing strategies.

This form of behavior enables the monopolist to maintain control over the market while increasing profitability through strategic pricing, converting potential consumer surplus into monopolist profit.