Page 669 - Krugmans Economics for AP Text Book_Neat

Perfect Price Discrimination Perfect price discrimination takes
place when a monopolist charges each
Let’s return to the example of business travelers and students traveling between Bis-
consumer his or her willingness to
marck and Ft. Lauderdale, illustrated in Figure 63.1, and ask what would happen if the
pay—the maximum that the consumer
airline could distinguish between the two groups of customers in order to charge each is willing to pay.
a different price.
Clearly, the airline would charge each group its willingness to pay—that is, the maxi-
mum that each group is willing to pay. For business travelers, the willingness to pay is
$550; for students, it is $150. As we have assumed, the marginal cost is $125 and does
not depend on output, making the marginal cost curve a horizontal line. And as we
noted earlier, we can easily determine the airline’s profit: it is the sum of the areas of
rectangle B and rectangle S. Section 11 Market Structures: Perfect Competition and Monopoly
In this case, the consumers do not get any consumer surplus! The entire surplus
is captured by the monopolist in the form of profit. When a monopolist is able to
capture the entire surplus in this way, we say that the monopolist achieves perfect
price discrimination.
In general, the greater the number of different prices charged, the closer the mo-
nopolist is to perfect price discrimination. Figure 63.2 on the next page shows a
monopolist facing a downward-sloping demand curve, a monopolist who we as-
sume is able to charge different prices to different groups of consumers, with the
consumers who are willing to pay the most being charged the most. In panel (a) the
monopolist charges two different prices; in panel (b) the monopolist charges three
different prices. Two things are apparent:
■ The greater the number of prices the monopolist charges, the lower the lowest
price—that is, some consumers will pay prices that approach marginal cost.
■ The greater the number of prices the monopolist charges, the more money extracted
from consumers.
With a very large number of different prices, the picture would look like panel (c), a
case of perfect price discrimination. Here, every consumer pays the most he or she is
willing to pay, and the entire consumer surplus is extracted as profit.
Both our airline example and the example in Figure 63.2 can be used to make an-
other point: a monopolist who can engage in perfect price discrimination doesn’t cause
any inefficiency! The reason is that the source of inefficiency is eliminated: all potential
consumers who are willing to purchase the good at a price equal to or above marginal
cost are able to do so. The perfectly price-discriminating monopolist manages to
“scoop up” all consumers by offering some of them lower prices than others.
Perfect price discrimination is almost never possible in practice. At a fundamental
level, the inability to achieve perfect price discrimination is a problem of prices as eco-
nomic signals. When prices work as economic signals, they convey the information
needed to ensure that all mutually beneficial transactions will indeed occur: the market
price signals the seller’s cost, and a consumer signals willingness to pay by purchasing
the good whenever that willingness to pay is at least as high as the market price. The
problem in reality, however, is that prices are often not perfect signals: a consumer’s
true willingness to pay can be disguised, as by a business traveler who claims to be a
student when buying a ticket in order to obtain a lower fare. When such disguises
work, a monopolist cannot achieve perfect price discrimination. However, monopolists
do try to move in the direction of perfect price discrimination through a variety of pric-
ing strategies. Common techniques for price discrimination include the following:
■ Advance purchase restrictions. Prices are lower for those who purchase well in advance
(or in some cases for those who purchase at the last minute). This separates those
who are likely to shop for better prices from those who won’t.
■ Volume discounts. Often the price is lower if you buy a large quantity. For a consumer
who plans to consume a lot of a good, the cost of the last unit—the marginal cost to
the consumer—is considerably less than the average price. This separates those who
plan to buy a lot, and so are likely to be more sensitive to price, from those who don’t.

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