A Note on Pricing With Market Power: Third-Degree Price Discrimination With Quality-Differentiated Demand

Abstract

The article points up limitations in the standard undergraduate treatment of third-degree price discrimination by monopolists. While such treatments allude to qualitative distinctions between higher and lower priced alternatives, failure to capture those distinctions in underlying cost and demand structures results in only partial and possibly misleading conclusions about the nature and consequences of such discrimination. Deriving quality-differentiated linear demand and cost structures from the constructs underlying undergraduate microeconomics, the article compares the standard analysis of price discrimination with one that explicitly accounts for quality choices and monopoly power in manipulating those choices. The analysis illustrates the potential for substantially greater monopoly profits and greater efficiency losses by forcing some groups of consumers into suboptimal quality choices once quality variations are explicitly accounted for. JEL Classifications: A1, A22, D11, D21, D42