How are prices determined in perfectly competitive and monopolistic markets and how does price discrimination affect consumers and suppliers?

In a perfectly competitive market, there are many suppliers and buyers, homogeneous goods are offered, and prices are determined by market supply and demand. In a monopolistic market, a single firm has the power to control prices and seeks maximum profit through price discrimination. Price discrimination can be categorized into first-, second-, and third-tier strategies, each of which sets different prices for different groups of consumers in different ways.

 

A perfectly competitive market is characterized by a large number of buyers and sellers and the homogeneity of goods, so suppliers and buyers accept the price determined by the supply and demand of the market as a whole. In such a market, individual firms or consumers act as price takers because they cannot influence the market price. In other words, all market participants are bound by the price set by the market and do not have the ability to adjust prices individually. This is one of the reasons why perfectly competitive markets are considered by economists to be the ideal market structure. Perfectly competitive markets allow for an efficient allocation of resources, which leads to optimal outcomes for both consumers and producers. Many small firms produce homogeneous goods, and the freedom to enter and exit the market ensures that resources are put to their most productive use.
A monopolistic market, on the other hand, is one in which the supply of a good or service is dominated by a single firm. In a monopoly, the sole supplier dominates the market and can set prices by controlling the amount of supply, which gives it a lot of market power. A monopolist can use its position as the only supplier in the market to set prices, which can lead to unfavorable outcomes for consumers. Monopolistic markets can lead to inefficient allocation of resources, which can lead to a reduction in social welfare. Therefore, monopolistic markets may require government regulation and intervention. Monopolies can limit consumer choice and reduce market efficiency by setting prices too high or restricting supply.
When a monopolist sells the same product produced under the same conditions to different consumers at different prices, it is called ‘price discrimination’. It’s a way for companies to set prices to maximize profits. There are three main forms of price discrimination: First-, second-, and third-degree price discrimination.
First-degree price discrimination is when a monopolist knows the willingness-to-pay, the amount that individual consumers are willing to pay for a good, and sells it to each consumer for the maximum price. In this case, the monopolist gets all of the consumer surplus. In practice, however, it is impossible to detect a monopolist practicing first-degree price discrimination because it is difficult for a monopolist to have accurate information about the willingness to pay of individual consumers. For example, for full first-degree price discrimination to occur, a firm would need to know the exact willingness to pay of each consumer, which is impractical due to information costs and ethical concerns. In theory, however, first-degree price discrimination is the most ideal form of monopolistic pricing, where the monopolist absorbs the surplus of all consumers, and is often mentioned in economics textbooks.
Second-degree price discrimination is when a monopolist presents consumers with several alternatives and allows them to choose one based on their willingness to pay. For example, a monopolist may divide a purchase into several tiers and charge a different price for each tier, forcing consumers to choose between them. Second-degree price discrimination also involves charging consumers less per unit when they purchase a product in larger quantities than when they purchase smaller quantities. These practices allow consumers to voluntarily choose a price based on their spending patterns, allowing companies to earn additional revenue from price discrimination. Second-degree price discrimination is common in the real world, for example, airlines and hotels charge different prices depending on the time of booking.
Third-order price discrimination involves separating consumers into two or more groups based on their characteristics. This method is based on predicting the demand curves of each group of consumers. Dividing consumers into several groups according to their characteristics means dividing the market into several groups, so it can be called price discrimination by market segmentation. For example, dividing consumers into groups such as students, seniors, and general adults and charging different prices to each group. This allows the company to maximize its total revenue by setting the optimal price, taking into account the price elasticity of each group. In addition, market segmentation helps the company to create marketing strategies that are tailored to the characteristics of each market.
Thus, through price discrimination, monopolists are able to divert consumer surplus to their own benefit, which in turn contributes to a significant increase in profitability. However, price discrimination doesn’t always have positive consequences. Price discrimination can increase the economic burden on consumers or undermine market fairness, which must be balanced by appropriate regulation. For example, price discrimination on public or essential goods can cause social controversy and require regulatory intervention. It is important to ensure market fairness and consumer protection through such regulation.