Chapter 5: Market Conduct of Dominant Firms I
87 The formal analysis usually proceeds by identifying three different types of price discrimination and it is convenient to retain that system here. Discrimination of the first degree refers to the extreme case where the seller is able to take advantage of their assumed complete knowledge of the reservation prices of a potential customer to their own considerable advantage. The position is illustrated in Figure 5.1.2 The demand conditions facing a dominant firm are shown by the line AR and the related marginal revenue by the line MR. The firm’s marginal and average costs are denoted MC and AC (and are assumed constant for simplicity). If the firm sold at a single price, it would maximize profit at PS, selling an output QS. However, if the firm had knowledge of the maximum price individuals would be prepared to pay for different units of output, it could increase its profits considerably. Thus if the ‘first’ unit is indicated by Q1, this would be sold at price P1. The next unit would be sold at the slightly lower price P2 (not shown in the figure) and so on down the demand curve. Under these conditions, the firm would be prepared to sell output up to point where the price of the marginal unit sold was equal to the marginal cost of production: Pc in Figure 5.1. We arrive at the rather surprising result that, if the dominant firm can discriminate in this extreme or perfect sense (with Figure 5.1 First degree price...
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