Motown Hydro is the sole electric supplier in Motown, and it has a cost function 0.05y (costs are measured per kilowatt-hour). Consumer 1 is a low-income customer with a demand function y1=100-500p. Consumer 2 is a higher income customer with a demand function y2=250-1000p. 1) Determine what would be the outcome (equilibrium price and quantity) if Motown Hydro could observe income of Consumer 1 and Consumer 2 and force price discrimination (your answer should include measurement of consumer and producer surplus)? 2) Determine what would be the outcome (equilibrium price and quantity) when Motown Hydro cannot observe the income level of Consumer 1 and 2 but the company has an idea about the different types of income level, and they can practice price discrimination by offering self-selecting prices. 3) Theoretically explain in detail about the types of price discrimination Motown Hydro is practicing. 4) Draw demand curve for each type, graphically illustrate all details for question (2) and show changes in consumer and producer surplus. 5) Can you determine the equilibrium price and quantity in the market? If yes, solve, if no, justify. 

Expert Answers

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In the first scenario, Motown Hydro is practicing first degree price discrimination, while in the second scenario Motown is practicing third degree price discrimination. Second degree price discrimination is not involved in the example scenarios because quantification of product being priced is not differentiated in the discriminatory pricing of either Motown example.

Price discrimination is practiced in industries with full monopoly or a degree of monopoly power: "The firm must have some degree of monopoly power" (EconomicsOnline.co.uk). The most common and concise definition of monopolistic price discrimination is: "Price discrimination is the practice of charging a different price for the same good or service" (EconomicsOnline.co.uk). The three kinds of price discrimination are first degree (individual based), second degree (quantification based) and third degree (group or subset based).

Some economists define these degrees from the perspective of the consumer, using language that emphasizes what the consumer is willing to pay and identifying discriminated groups by differentiation such as (1) individual willingness to pay price discrimination, (2) demographic willingness to pay price discrimination, and (3) consumer group or subset willingness to pay price discrimination.

Some economists define these degrees from the perspective of the producer. My preference is for defining price discrimination from the perspective of the producer (instead of the consumer). From the producer perspective, language is used that emphasizes the different prices charged for the same good or service. The discriminated groups are identified by differentiation of (1) charging the maximum price for each unit of good or service to capture all consumer surplus across all potential consumers; (2) charging different prices for different quantities of product; (3) charging different prices to different consumer groups or sets.

By these definitions and differentiations, in the first scenario Motown is maximizing the price they charge for each unit to Consumers 1 and 2 in order to capture all available consumer surplus across all present consumers, thus they are practicing first degree price discrimination. By definitions and differentiations, in the second scenario Motown has general knowledge of the income levels of two consumer groups, Consumer 1 and Consumer 2, and are, through pricing self-selection, charging different prices to different groups or sets of consumers, thus they are practicing third degree price discrimination.

Quantity of good or service is not a consideration in the two example scenarios, so second degree price discrimination is not involved. To clarify, if Motown charged price variations based upon consumption (e.g., 10% off if you consume less than the average household of 12,000 square feet), this would represent second degree price discrimination.   

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