Environmental Regulation, Market Power and Price Discrimination in the Agricultural Chemical Industry

The welfare consequences of price discrimination, relative to the benchmark of a
single price charged by a monopolist when marginal costs are constant over the relevant
range of the firm’s cost function, are as follows. In a two market world, when markets
are segmented and price discrimination is introduced, in terms of economic surplus,
consumers in the high price market are worse off while consumers in the low price
market are better off because price rises in the market with the relatively inelastic demand
curve and falls in the market with the more elastic demand curve. Producer welfare
increases and total economic welfare also increases.

In the two market case, whether or not buyers as a whole are better or worse off
under price discrimination depends on the shapes of the compensated demand curves.
However, if market segmentation is complete (in that each buyer is segmented from all
other consumers) and the firm practices first order price discrimination, then consumer
surplus falls to zero as the firm captures all rents and buyers as a whole are clearly worse
off. In addition, third order price discrimination will generally increase aggregate
economic welfare relative to a monopoly single-price equilibrium when economic
welfare is measured by the simple sum of producer and consumer surplus. The
monopoly producer gains as do buyers in the low-price market, but buyers in the high-
price market will lose. On a net basis, buyer welfare losses in the high-price market may
or may not more than offset the gains in the low-price market and so buyers as a whole
could be either worse off or better off.⁴

⁴ See, for example, Varian (1989), and more recently Clerides (2004), Stole (2001), and Yoshida (2000).
The aggregate effect on consumer welfare depends on the shape of the compensated demand curves in the
two market case, but as market segmentation increases so does the likelihood of reductions in aggregate
consumer welfare. In the limit, under perfect or first-order price discrimination, all economic welfare
accrues to the monopolist.

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