Price Discrimination and Market Power

Abstract

February 25, 2005 ABSTRACT. If there is price discrimination, at least one of the prices is not equal to marginal cost. Therefore, if there is price discrimination, there must be market power. While this logic is sound, it has led many policy-makers to believe that price discrimination and market power are positively correlated. We present a model where measured price discrimination can be low while market power is high, and price discrimination can be high while market power is low, thus demonstrating that there is no theoretical connection between the strength of price discrimination and that of market power. We then present new evidence that price discrimination is negatively correlated with market power in the US airlines industry. (JEL L41 L93) Price discrimination is commonly viewed as an indication of market power. Disadvantaged buyers, who realize that a firm is charging them a higher, and seemingly more profitable, price than it is charging similar buyers for the same good, are naturally given to protest and accuse the firm of monopoly. Economists, on the other hand, have a less emotional reason to view price discrimination as indicative of market power. In a competitive market, price equals marginal cost. Wherever there is price discrimination, at least one of the prices deviates from marginal cost. Therefore, if there is price discrimination, there must be market power (see, for example, Varian, 1989, and Stole, 2003). Antitrust scholars have employed similar logic: Persistent price discrimination is very good evidence of market power because it is inconsistent with a competitive market; it implies that some consumers are paying more than the cost of serving them, a situation that