Price Discrimination, Economies of Scale, and Profits

Abstract

The debate in economics about whether third-degree price discrimination by a firm with monopoly power is socially beneficial or not has gone on a long time. In fact, the debate goes back to Pigou (1920) and Robinson (1933). Two main reasons why third-degree price discrimination affects welfare are the fact that different groups of buyers are charged different prices leads to a misallocation of output and the total output under price discrimination may differ from total output under uniform pricing. Schmalensee (1981), Varian (1985), and Schwartz (1990) show that welfare falls if total output is the same or lower under price discrimination than under uniform pricing. That is, in order for price discrimination to yield a higher welfare, a necessary but insufficient condition is that total output be higher under price discrimination. In this connection, Hausman and Mackie-Mason (1988) argue that price discrimination is most beneficial when there are economies of scale. On the other land, Layson (1994) shows that it is possible for economies of scale to decrease the welfare gains from price discrimination rather than increase them.