Price Controls under Third-Degree Differential Pricing Open Access

Namura, Tomoko (2012)

Permanent URL: https://etd.library.emory.edu/concern/etds/8c97kq92x?locale=en
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Abstract

This paper examines the effects of a price control in a smaller of the two monopolistic but
different sized markets. Studying such effects in third-degree differential pricing situation, where
a monopolistic firm charges different prices according to the demands in different markets, I
introduce two models. In Model 1, the firm has a constant marginal cost. In this model, a price
restriction placed in the smaller market will only increase the demand in this market, and no
changes will take place in the other market. Furthermore, in Model 1, the government will most
likely set the price ceiling near the marginal cost to achieve the maximum level of consumer
surplus without driving the firm out of the market. In Model 2, in which the firm has a linearly
increasing marginal cost, as the government of the market with a smaller demand lowers the
price, there comes a price where the firm no longer supplies that market on the demand.
Additionally, I propose that the government considers deadweight loss when setting the price
ceiling, so that the increase in consumer surplus never goes above the deadweight loss.
Understanding the effects of price ceilings under third-degree differential pricing provides add to
the theory of pricing behavior by monopolies in general and also the pharmaceutical market.

Table of Contents

1. Introduction …………………………………………………………………….………………..………………..……………….. 1

2. Model 1: Third-Degree Differential Pricing with Constant Marginal Cost …………………….......... 6

3. Model 2: Third-Degree Differential Pricing with Linearly Increasing Marginal Cost ………………. 10
a. Regime 1 - Supplying at the Demand Curve in Market 2 with Price Control ……..……………..... 12
b. Regime 2 - Supplying Below the Demand Curve in Market 2 with Price Control ……………….... 15
c. Turning Price between Regime 1 and Regime 2 ………………………………..……..……..……..……...... 18
d. Effects of a Lower Price Regulation on Consumer and Producer Surplus ……………............... 19

4. Discussion and Conclusion ……………………………………………………..…………………..…………………...... 25

5. Appendix: Figures ……………………………………………………………….…………….…………….……………....... 28

6. References ……………………………………………………………………….……………….……………….………………... 37

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