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Difficulty: MediumMonopoly: Price Discrimination Conditions, Types, and Effects

A state-owned electric power distribution company operating as a monopoly charges domestic households a higher rate per kilowatt-hour than industrial factories. For this pricing policy to successfully increase the monopoly's total revenue, which condition regarding demand elasticity and market structure must hold?

  1. Domestic households must have a relatively price-inelastic demand, and seepage between the domestic and industrial sub-markets must be prevented.Answer
  2. B
    Domestic households must have a relatively price-elastic demand, allowing the firm to gain greater total revenue by charging higher unit prices.
  3. C
    The pricing strategy must completely eliminate consumer surplus in both sub-markets by charging each individual consumer their maximum willingness to pay.
  4. D
    Raising electricity rates for domestic households will cause an outward shift in their demand curve, leading to higher consumption at higher prices.

Answer

Domestic households must have a relatively price-inelastic demand, and market seepage (arbitrage) between sub-markets must be strictly prevented.
For third-degree price discrimination to increase total revenue, the monopolist must charge a higher price in the sub-market where demand is relatively less price-elastic (inelastic) and ensure the sub-markets are separated so buyers cannot purchase in the cheaper market and resell in the dearer market.

Step-by-Step Solution

1
Identify the type of price discrimination described in the scenario.
Charging different prices to distinct consumer groups (domestic vs. industrial) based on market segmentation represents third-degree price discrimination.
The monopolist separates buyers into identifiable sub-markets rather than charging individual prices or block tariffs to single consumers.
2
Apply the price elasticity rule for third-degree price discrimination.
Higher prices must be assigned to the sub-market with lower price elasticity of demand (∣Ed∣<1|E_d| < 1), while lower prices are assigned to the sub-market with higher price elasticity of demand (∣Ed∣>1|E_d| > 1).
Inelastic demand means price increases lead to a smaller percentage decline in quantity demanded, thereby increasing total revenue in that sub-market.
3
Verify structural prerequisite conditions for successful discrimination.
The firm must possess monopoly power, sub-markets must be clearly separable, and arbitrage (seepage/resale) must be impossible.
If industrial buyers could resell low-cost electricity back to domestic consumers, the price differential would collapse.

Key Concept

Conditions for Third-Degree Price Discrimination
Estimated Time:1m 15s
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Topics

Monopoly: Price Discrimination Conditions, Types, and Effects

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