1.3.

1 First-Degree Price Discrimination

First-degree price discrimination occurs if the monopolist charges different prices

both across units and across individual customers. Ever since Pigou (1920),19 it has

been common to equate first-degree price discrimination with perfect discrimination

where the monopolist generates the maximal gain from trade and captures all of

it. But this identification leaves out the possibility of imperfect first-degree price

discrimination.

A perfectly discriminating monopoly must know the marginal willingness to pay

of each potential customer, prevent customers from engaging in arbitrage transactions,

and unambiguously convey to customers that it is pointless to haggle. Within

this general framework the monopolist can succeed with one of two simple pricing

schemes.

One way to go is a customized take-it-or-leave-it-sales plan

S(:={(7},x,),(0,0)}. (1.26)

There, each customer / is offered to either buy the stipulated JC/ units for the total

price 7/, or leave it (0, 0). To capture the maximum gain, the monopolist only needs

to offer the efficient quantities, implicitly defined by the "price = marginal cost"

requirement (where X := ]T • Xj)

Pi(xi) = C'(X) for all /, (1.27)

and set 7} equal to /'s maximum willingness to pay for x/.

Another way is to offer customized two-part tariffs

S<:={(ti,fi), (0,0)} (1.28)

that prescribe a certain unit price t[ plus a lump-sum price ft. In order to capture the maximum gain, t[
needs to be set equal to the marginal cost Cf(J2j •*/)>
fi at the level where the total price equals /'s maximum willingness to pay. Then
allow each customer to buy as many units as he likes, unless he chooses the no-buy
option (0,0).
The two methods of sale are equivalent as long as complete information and
exclusion of arbitrage prevail.
An immediate implication of optimal first-degree price discrimination is that it
maximizes social surplus. Hence, one arrives at the somewhat paradoxical conclusion
that the strong monopolist gives rise to efficiency of output, whereas the
monopolist that exercises restraint and adopts a uniform linear price function contributes
to a welfare loss.
However, keep in mind that higher monopoly profits give rise to more wasteful
expenditures in the course of the competition for the market. In Section 1.2.3
we showed that monopoly profit is a good statistic of this underlying waste. This
suggests that first-degree price discrimination is the least efficient among all conceivable
market forms. True, once a monopoly position has been acquired, perfect
price discrimination maximizes the social surplus. But the entire social gain is completely
eaten up by wasteful expenditures in the course of the preceding competition
for the market.