How can price discrimination arise from significant market power?

Price discrimination can arise from significant market power when a firm can influence prices and segment markets.

In a competitive market, firms are price takers, meaning they have no control over the price of the goods or services they sell. However, when a firm has significant market power, it becomes a price maker, able to set its own prices. This ability to influence prices can lead to price discrimination, a practice where a firm charges different prices to different consumers for the same good or service.

Price discrimination can occur when three conditions are met. Firstly, the firm must have market power, which means it can influence the price of its product. This is often the case in monopolies or oligopolies, where there are few competitors. Secondly, the firm must be able to segment its market, meaning it can divide its customers into different groups based on certain characteristics, such as location, age, or income level. Lastly, the firm must be able to prevent resale, ensuring that consumers who buy a product at a lower price cannot resell it to those who are charged a higher price.

Market power allows a firm to differentiate prices based on the price elasticity of demand in different market segments. If a segment is more price sensitive (elastic demand), the firm will charge a lower price. Conversely, if a segment is less price sensitive (inelastic demand), the firm will charge a higher price. This is known as third-degree price discrimination.

For example, a firm with significant market power may charge higher prices in a wealthy neighbourhood (inelastic demand) and lower prices in a less affluent area (elastic demand). Similarly, a firm might offer discounts to students or seniors, who are typically more price sensitive.

In essence, significant market power allows a firm to engage in price discrimination by influencing prices, segmenting markets, and preventing resale. This can lead to increased profits for the firm, but may also result in consumer welfare losses, particularly for those consumers who are charged higher prices.