The monopolist adds to his total revenue and profits through price discrimination. In this process he manages to get hold of the whole or a portion of consumer surplus according to what the traffic will bear.
Accordingly, A.C. Pigou has distinguished price discrimination into those of first degree, second degree and third degree depending upon the extent to which the monopolist can appropriate the consumer surplus from the consumers.
(A) First Degree Price Discrimination:
First degree price discrimination is the limiting or extreme case of price discrimination, which is not a practicable price policy. Here, the monopolist charges maximum possible price for each unit of the product according to willingness of individual consumer to pay, leaving no consumer surplus with him.
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It arises in those situations, where the monopolist is able to deal individually with each consumer for every unit of the product he sells, to determine all-or-nothing bargain and for preventing retransfer of purchases among buyers. Price determined by haggling with individual party for the price quoted in the tenders is an example.
However, this is not administratively feasible, especially when, there exist innumerable consumers in the economy. However, this would be most advantageous to the monopolist, if it could be employed by exploiting each buyer to the degree each one allows himself to be exploited.
Under this kind of price discrimination, the monopolist manages to grab the entire consumer’s surplus under the threat of denying the sale of any quantity to him, otherwise. Since the monopolist offers each consumer a take-it-or-leave-it choice, the first degree price discrimination is also known as ‘take-it-or-leave-it’ price discrimination.
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Here, the monopolist may be able to sell each individual unit of the product at different price to the same consumer. In other words, it involves maximum exploitation of the consumers through a complete siphoning off the consumers surplus by the monopolist.
That is why; Joan Robinson calls it perfect discrimination. This situation of price discrimination is illustrated in Fig. 14.12, where demand curve DD, shows the sale of each unit of output at its corresponding willingness price.
In this figure, total revenue for OQ units of the product is shown by the shaded area, i.e., no consumer surplus is left with the consumers. Since every time the consumers are charged according to their demand function, the demand curve shows the addition to revenue for each additional unit sold by the monopolist.
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Hence, the demand curve becomes the marginal revenue of the monopolist. Given marginal cost MC, the profits of the monopolist are given by the area ADC, which is more than profits shown by the area ADB under simple monopoly (the area between marginal revenue and marginal cost)
(B) Second Degree Price Discrimination:
The second degree price discrimination is said to arise, when the concerned monopolist is in a position to extract a large part of the consumer surplus by selling different quantities of his product at more than two prices to different groups of consumers according to their willingness to pay or otherwise.
The idea here is not be capture the whole consumer surplus as in the previous case of first degree price discrimination. The price charged for each group/sub-group is equal to what a marginal individual unit of that group is just able to pay.
Further, unlike first degree discrimination, second degree price discrimination is not hypothetical altogether. The second degree price discrimination is often adopted by public utility enterprises like electricity, gas supplies, telephones, water works, etc.
This pricing rule is also followed by several departmental stores to give incentives for expanding sales. Various types of discounts according to volume purchased may be given for this purpose.
Fig. 14.13 illustrates the case of second degree price discrimination, where the monopolist manages to sell his product to four different groups or blocks. Given the market demand curve DD’, the demand price for first OQ, units is OP,, as marginal individual unit Q, is just able to pay this price and P, DB, is the consumer surplus.
Likewise, for next Q1Q2, Q2Q3 and Q3Q4 units, consumers pay OP2, OP3 and OP4 and get the consumer surplus equal to C1B1B2, C2B2B3 and C3B3 B4 as shown by shaded areas in Fig. 14.13. The second degree price discrimination is also known as block pricing. One can have as many blocks as one desires depending on feasibility. When each separate unit of the good constitutes a block, we approach first degree price discrimination.
(C) Third Degree Price Discrimination:
Under third degree price discrimination, the monopolist divides the market for his product into two or more sub-markets with different price elasticities of demand and charges different prices from each one of them. In this manner, he treats each sub-market as a separate market. This is the most common form of price discrimination.
Different prices may be charged from private companies, Government and educational institutions. Concessions to students in publications, circus, cinemas and transportation are other examples. Unlike second degree price discrimination, here the price charged in each sub-market need not be the lowest demand price which the marginal unit of the product in sub-market is able to get.