Question

Discuss and illustrate with a graph third degree price discrimination. What conditions are necessary and how would we expect it to affect the profits of the firm?

Answer 1

Under third degree price discrimination, market is divided into segments and different prices are charged to each segment. Marginal cost, MC is same across all segments but marginal revenue, MR is different. Profit maximising quantity is determined with MRi = MC where i is market segment.

In the graph two segments are shown where market 1 is willing pay higher prices than market 2.

To segment market it is necessary that markets are completely separated and no trade is possible between markets. Also seller is able to differentiate consumers or markets based on their willingness to pay, in short he should know consumers' willingness to pay.

Profit increases with third degree price discrimination as consumers whose willingness to pay is less will not buy goods at higher price. So Monopoly's sales increases with price discrimination which increases its profit.