Monopolistic Competition And Pricing Discrimination

Monopolistic competition in the long run

• In both monopoly and monopolistically competitive market, the firm maximises their profit at the point where the MR is equal to the marginal cost. In both the cases the profit maximisation point is where the MC intersects the MR curve from below.
• In both the market setting the average revenue curve or the demand curve is downward sloping. This means the firm operating in both the markets experiences some degree of loyalty from the customers of the market.
• Furthermore, in both the market setting the firm produces at the point where there is super normal profit in the short run. That means the price at which the firm produce is more than the marginal cost of production.
• Lastly, in both the cases, the firm is a price maker and the customers of the market are the price taker. That means the firm in these markets sets the price and the consumers take the price as given.

Figure 1: monopolistic competition in the long run

(Source: Developed by the learner)

The figure above shows that in the short run the firms in the monopolistic competition earns super normal profit as shown in the left side diagram of the figure. On the other hand the super normal profit becomes normal profit in the long run. This is due to the increase in the number of the firms in the market that enters the market in search of super normal profit. This pushes the average total cost and the marginal cost of production upwards leading to a reduction in the profit. The super normal profit falls until the super normal profit becomes exactly equal to the normal profit in the long run. After that the firms that enters the market produces at the point where the price is lower than the minimum level of ATC and hence shuts down.

In the case of perfect competition the marginal revenue curve is equal to the average revenue curve since the firm in this market is the price taker. Therefore the curve is horizontal to the x axis and merges with the average revenue curve. The marginal revenue function in case of the perfectly competitive market is thus a constant function. On the other hand in both the cases of monopoly and monopolistically competitive market, since the firms are price setters, the marginal revenue is downward sloping line with slope twice than that of the average revenue. In these cases, the MR curve lies below the AR curve in both the cases of monopoly and monopolistically competitive market.

Under the block pricing discrimination or the second degree price discrimination the firm charges different prices based on the different output demanded.

Figure 2: The deadweight loss under monopolistic market

(Source: Developed by the learner)

Under monopoly, the price is set at the point where the marginal cost is equal to the marginal revenue. This creates some dead weight loss in the society which is shown using the purple colour in the above diagram. Now as the firm starts implementing block pricing, the firm becomes able to extract rest of the consumer surplus from the market. Therefore the dead weight loss reduces.

Figure 3: The dead weight loss under block pricing

(Source: Developed by the learner)

The figure above shows that due to the block pricing, the consumer enjoys some level of surplus due to fixed price on each blocks. These get added to the societal surplus. On the other hand the producer or the firm also enjoys higher level of surplus since it extracts more surpluses from the market. This results in the dead weight loss to fall as shown in the above diagram.

Group pricing discrimination or the third degree price discrimination is a pricing discrimination done by the monopolist to charge different price to different set of market. Generally, the monopolist sets higher prices for the market with lower elasticity of demand and sets low price for the market with higher elasticity of demand. This way, the firm becomes able to extract more surpluses from the market thereby increasing its producer’s surplus.

Marginal revenue and average revenue in different market structures

Figure 4: The dead weight loss of the monopolistic firm in single pricing model

(Source: Developed by the learner)

Under the single pricing model the monopolist charges a single price for all the customers of the market irrespective of the type and elasticity they have. Therefore, the monopolist loses some part of the potential producers’ surplus that could have reduced the dead weight loss. By differentiating the two markets using the group price discrimination, it charges different prices to different market. Therefore each of the groups becomes separate monopoly market under the main monopoly. Now under each of the group market, there will be dead weight loss which can be either more or greater than the single pricing model market. This is depends on the price which is charged by the firm in group pricing model and the respective elasticities of demand for the product.

Figure 5: The dead weight loss under the group price discrimination

(Source: Developed by the learner)

As can be seen from the above diagram, the dead weight loss can be different based on the price that the monopolist charges. If the price is lower for the second segment the dead weight loss will be different compared to the situation if the prices were higher. Therefore dead weight loss can be either more or less compared to the single price model, if compared with the group price discrimination process of the monopolist.

(Source: Developed by the learner)

The figure above shows the impact of taxation on the welfare of the society. That figure shows that at P1 the linear demand and linear supply curve intersects at a point where the market clears and produces Q quantity of goods. Now if a tax of “t” is imposed in the production of the goods, the cost of production of the goods and the services will increase. Since the tax is imposed on the production of the goods the supply curve will shift to the left side. That means at each level of price the supplier would be able to produce fewer quantity of goods in the market. Since the tax is not directly imposed on the customers of the market, the demand curve will not get affected by the imposition of the tax. The new intersection of the demand and the supply curve as shown in the figure will be at the point where the price will be P2. Here the consumers’ surplus will reduce and the producers’ surplus will increase. The consumers’ surplus will reduce since the area between the price and the demand curve has reduced due to the tax. On the other hand the producers’ surplus will also reduce since area above the supply curve and below the price level has reduced. The governments’ surplus is the revenue generated from the tax imposition which is shown using the rectangular area in the diagram. The red triangular area is not owned by anyone in the market and hence this area is lost from the society. This is the dead weight loss of imposing tax of size “t” in the market

Now if the demand curve is more inelastic that means the demand is steeper than before, the consumers of the market will be less responsive to the changes in the price of the goods. Now if the similar tax of size “t” is imposed in the market, the cost of production of the goods and the services will increase since the tax is imposed directly on the production. The producers of the market will be able to produce fewer number of units at any given price level and hence the supply curve will shift to the left side. On the other hand the demand curve will remain the same since the tax on production does not influence the customers of the market directly. Therefore new equilibrium will emerge in the market at the intersection of the old demand and new supply curve. Now since the customers of the market are less responsive to the changes in the price level, the producers will transfer more of the burden to the customers without losing demand for the goods much. In this case the tax revenue of the government will also rise since the fall in the quantity demanded will be less than before due to the imposition of the taxes. The producers will receive price which is closer to the previous price and the consumers of the market will pay way more than before without reducing much demand for the goods.