Economics Of Price Discrimination: Effects On Consumer Surplus And Welfare - Cambridge Essay.

Effect of Two Policies on Consumer Surplus and Welfare

Discuss About The Economics Of Price Discrimination Cambridge.

Read the following article on the issue of how national parks in the Us cope with the large number of visitors: https://www.google.com.au/amp/s/www.mnn.com/earth-matters/wilderness-resources/stories/amp/should-we-limit-visitors-national-parks.

Assume that the National park services want to restrict the number of visitors to Yellowstone to 3m visitors a year, which is smaller than the current record at 4.3m. They consider two policies:

1. Raising the price of admissions, and
2. Setting a quota that limits the number of visits to 3m

Compare the effect of these two policies on consumer surplus and welfare. User a graph to show which policy is superior.

Considering the figure beneath, which has taken an assumption of the park services to have a constant MC=P0 to allow visitors get into the park. At the initial prices, P0, the consumer surplus is denoted by the equation A+B+C, having no any producer surplus. When the park officials decide to moderate the number of customer visits to Q*=3m, they can opt to increase the prices to P1, which in turn will reduce customer surplus by B+C, or decide to introduce a quota and maintain the prices untouched (Hicks, 2012, p.696). 

If the officials decide to escalate the prices to P1, the consumer surplus will fall to the area A (depicting a decline by B+C), on the other side producer surplus upsurges to B, and the deadweight loss = C (Neven & Roller, 2015, p.829).
Consequently, If the park officials uses the quota approach and leaves the price untouched, the consumers remain in area A+ B. Though, since at point P0 the demand is higher than the quota Q*=3m, the consumer prices are likely to increase. This basically happens, for instance, because of the waiting in line duration or the establishment of the black market. As a result the customers end up having the same customer surplus just like when the higher prices are charged. The Area denoted by letter B is either seized by the black markets or it becomes an opportunity cost for the extra time spent by the consumers in line. The Area denoted by C is a deadweight loss zone (Neven & Roller, 2015, p.829).

Stopping an electricity plant permanently would be very expensive considering the fact that the modern society utilizes electrical power at high rates. Such a power is generated at the power plants and that normally convert other kinds of energy into the electrical power.

Electricity is generated at the electric power plants. Some sources of fuel, like coal, nuclear energy, oil and natural gas also produce heat. The heat produced is then used in boiling water to produce steam which under extreme pressure runs the turbines. The running turbines interact with magnetic systems to generate electricity power. The electricity power generated is transmitted in form of electrons through wires to homesteads and businesses (Hicks, 2012, p.696).

Explanation of Why Closing an Electricity Plant Permanently Would be Costly

Most of the power plants also generate greenhouse gases. It has become one among the leading supplies of greenhouse gases emission in U.S. The Power plants burning fossil fuels and other materials prepared from fossil fuels are the main sources of almost 40% of energy-related to CO2 in United States. Most of the power plants levy consumers more at peak hours. The overuse will lead to scarcity in energy supply hence increasing the overall cost of electricity. Mining coal or drilling natural gas to meet the excessive demands for energy negatively impacts the environment (Hicks, 2012, p.696).

1. Under what circumstances will a drug company charge more for its drug after the patent expires

To briefly elaborate on this matter, when a firm invents a new drug into the market, the patent laws usually gives such a firm a monopoly right to sell the drug. But when the patent expires, the rest of the companies are allowed to sell the drug also (Nogués, 2014). Basically, the price charged by the monopoly is above the marginal cost of making such a drug. In a real scenario, when the patent expires, the new firms  enters the market to make it more competitive and result into price declines from the monopoly prices to the marginal cost as shown below (Balaram, 2015, p.1527)                      

However, there are special cases where the prices charged by the monopoly company upsurges rather than decrease

1. If the new companies opens up international markets leading to excessive demand for such a drug, the prices in turn will increase
2. If the new companies enter the market as manufacturers of such a drug, the demand for raw materials increases leading to increased prices of such raw materials on the other hand, the prices for the drug in the monopoly company will increase to bridge the gap in the prices (Chou &Shy, 2013, p.304).
3. Proposals to reduce patent length for drugs are sometimes made, but some critics argue that such a change would result in even higher prices during the patent period as companies would need to recover drug development costs more quickly. Is this argument valid if drug companies maximize profit?

This argument is extremely valid. One thing which is very clear about invention is that it is usually very costly. Considering the costs of prototyping, testing different ideas which are prone to failure in each step until one of them succeeds. All the costs incurred throughout this process are expected to be compensated at the period when the company or the firm is covered by the patent laws. And failure to recover the costs at such a period would pose a possibility of not recovering the costs after the period expires (Chou &Shy, 2013, p.304). Under such a circumstance, the firm would have done a zero work in its efforts to invent such a drug and no firm or company would settle to experience such a frustrations. So, in a case where the patent periods are reduced, the firms will do whatever it takes to make sure that they compensate the costs incurred during the invention period even if it means tripling the prices for the produc (Chou &Shy, 2013, p.304)..

You may have experienced or observed that for the same trip, you pay different prices depending on the direction you are travelling. Discuss the reasons for this practice by the Airlines.

The reason behind this case scenario lies under the reasons which necessitate price discrimination (Phlips, 2013). To add on this, it is without reasonable doubt that this practice by the airlines is a live example of price discrimination. Price discrimination is a common practice among the monopolistic firms which is occurs due to three reasons (Schmalensee, 2011, p.242)

1. As a rational strategy to maximize the profits in a monopolistic environment
2. Separation of customers as per their willingness to pay

• To raise the economic welfare of the whole society

The rise in welfare as a result of price discriminations emerges as higher profits for producers rather than the higher consumer surplus.

From the above three reasons, the first reason has been the main especially in the monopolistic markets.

Case 1) As a rational strategy to maximize the profits in a monopolistic environment (The perfect price discrimination)

It is a case where a monopolist realizes that the buyers are willing to pay perfectly. To illustrate more on this case, I will compare a monopolist with single price and a monopolist with perfect price discrimination (Corts, 2016, p.306)

1. A monopolist with a single price                                                                                                                                 

This diagram indicates a monopolist whose price charges are constant regardless of the direction. As a result, the total surplus in the market is equal to the total profit (producer surplus) and the customer surplus.

1. Monopolist exercising price discrimination

Under this category, the monopolist exercises perfect price discrimination. Since the consumer surplus is equal to zero, the total surplus balances with firm profits. Comparing the two, price discrimination can be seen to have the ability of increasing profits, raising the total surplus and lowering the consumer surplus (Schmalensee, 2011, p.242).

References

Neven, D.J. and Röller, L.H., 2015. Consumer surplus vs. welfare standard in a political economy model of merger control. International Journal of Industrial Organization, 23(9-10), pp.829-848.

Hicks, J.R., 2012. The foundations of welfare economics. The Economic Journal, 49(196), pp.696-712.

Corts, K.S., 2016. Third-degree price discrimination in oligopoly: all-out competition and strategic commitment. The RAND Journal of Economics, pp.306-323.

Schmalensee, R., 2011. Output and welfare implications of monopolistic third-degree price discrimination. The American Economic Review, 71(1), pp.242-247.

Phlips, L., 2013. The economics of price discrimination. Cambridge University Press.

Balaram, P., 2015. Patents, laws and science. Current Science, pp.1527-1528.

Nogués, J.J., 2014. Patents and pharmaceutical drugs: understanding the pressures on developing countries (Vol. 502). World Bank Publications.

Chou, C.F. and Shy, O., 2013. The crowding-out effects of long duration of patents. The Rand Journal of Economics, pp.304-312.