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Beyond price discrimination: welfare under differential pricing when costs also differ

By  |  February 20, 2013

Posted by D. Daniel Sokol

Yongmin Chen (University of Colorado) and Marius Schwartz (Georgetown) have written about Beyond price discrimination: welfare under differential pricing when costs also differ

ABSTRACT: We extend the analysis of monopoly third-degree price discrimination to the empirically important case where marginal costs also differ between markets. Differential pricing then reallocates output to the lower-cost markets, hence welfare can increase even if total output does not, unlike under pure price discrimination. To induce output reallocation the firm varies its prices but—again, unlike under pure price discrimination—with no upward bias in the average price. Due to this price dispersion, differential pricing motivated solely by cost differences will increase consumer surplus (and total welfare) for a broad class of demand functions. We also provide sufficient conditions for beneficial differential pricing in the hybrid case where both demand elasticities and marginal costs differ.