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Should firms price discriminate - Essay Example

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History of economic thought states that the main objective of the firm is to minimize its cost and to maximize its profit using any legal methods available. Therefore, we can conclude that it would be profitable for a firm to apply price discrimination (PD). However, we should…
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Should firms price discriminate

Download file to see previous pages... Therefore, PD can be defined as the situation in which price charged to a customer can be based partly on the value of the good to the customer, rather than just on the cost of producing the good itself (Paul, 1987). As a result, allowing a firm to capture all or most of the consumer surplus, increasing overall profit of the firm. Although this definition is different, it highlights an importance of utility and consumer surplus theorems allowing us to analyze how firms might use their monopoly power. In other words, how PD could be applied, so maximum profit can be gained in different monopoly markets.
First of all in order to discuss the usefulness of PD as a profit maximizing tool, we should identify the conditions that firm must meet in order to price discriminate. According to Fritz Machlup, (Fritz, 1955)there are three main prerequisites, firstly, a firm has to have the monopoly power in order to set the price. For example, if a firm is a price taker and its operates in perfectly competitive market it cannot price discriminate as demand curve is perfectly elastic, therefore there is no consumer surplus to capture, whereas if a firm is a monopoly it has a downward sloping demand curve therefore, there are some consumers who are willing to pay more than the uniform price. Secondly, for different groups of consumers it is necessary to have different price elasticity. For example, assume that all consumer groups have the same price elasticity then ceteris paribus; monopoly firm does not have an incentive to apply PD as the profit will be the same as a firm would have applied single price strategy. The third criteria, is that a firm must be able to prevent an arbitrage, in other words preventing resale of its products. For instance, why do Apple restricts on the number of IPhones that can be purchased, it is not because Apple products are exclusive, the reason is to prevent an arbitrage. Some people might buy IPhones in the US and sell them in the ...Download file to see next pagesRead More
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