PRICE DISCRIMINATION IN IMPERFECTLY COMPETITIVE MARKETS

This study analyzes third degree price discrimination in a model of an industry in which firms sell differentiated products and compete with prices. Two bases for discrimination are distinguished: brand elasticity, which measures the degree of substitutability between competing firms products, and industry demand elasticity, which is related to the underlying reservation price for the product of the industry. Conditions are obtained which determine the effect of discrimination on total output and total surplus. When industry structure is taken as exogenous and markets are approximately competitive it is shown that discrimination based only on differences in brand elasticity has unambiguously negative effects on both total output and surplus while discrimination based only on differences in industry demand elasticity has unambiguously positive effects on these variables. This contrasts with the result of Robinson for the monopoly case that discrimination based on differences in industry demand elasticity has ambiguous effects. The effects of discrimination are also analyzed when the number of firms is determined according to the Salop zero profit free entry condition. In this case, discrimination tends to reduce total surplus because it results in excessive variety.;It is then assumed that buyers differ in their preference for quality and that firms cannot observe this characteristic. The Nash equilibria of the game in which firms compete with product lines of prices and qualities which satisfy self-selection constraints is characterized. In equilibrium there is a positive correlation between quality and profit and the quality provided may be less than the socially efficient level extending the results of Mussa and Rosen for the monopoly case to a Bertrand competition environment.