The third assumption is that each firm in the industry has (or is perceived to have) a differentiated good or service when compared to those of its competitors. Therefore firms can alter prices without large shifts in demand, which implies that a monopolistically competitive firm faces a downward sloping demand curve, although the curve will have a relatively gradual slope due to the availability of substitutes. The final assumption of monopolistic competition is that as a result of firms having small amounts of monopoly power, ‘each one ignores the possible reactions of its competitors when it makes it own price and output decisions’ (Lipsey and Chrystal 1999: 174).
Price Discrimination
Price discrimination can exist when three conditions are met; consumers differ in their price elasticity of demand (PED) values for the given good or service, which a firm is able to distinguish, a firm has a degree of market power and the firm can prevent or limit arbitrage. If consumers have identical demands for a product, then all consumers would demand the same amount of the product for each price and the price and quantity of the product would depend on the number of consumers in the market along with the ability of the firm to supply the good or service. If firms have no market power, that is, no ability to affect the price of the products they sell, the theory of perfect competition infers that all goods will be sold at one price regardless of the level of output. Finally, if consumers can arbitrage price differences, any attempt to charge higher prices to a particular group of consumers would be defeated by the resale of such produce.
As a firm profit maximises, output (Q) will take place where marginal revenue is equal to marginal cost (MR=MC). Therefore price and output will take place at P1 and Q1 respectively. If the firm is able to charge a different price for each unit of output, the consumer surplus (EP1A) will be lost, the demand curve (DD) will become the marginal revenue curve (MR) and the firm will produce at C. Subsequently, output will rise from A to C and as a result, marginal profits will increase by ABC.
There are many advantages and disadvantages, both to individual firms and the industry as a whole from the use of price discrimination. One advantage is that firms will have increased revenue and profits, which will enable some to stay in business who may otherwise would have made a loss and allow others to reinvest in research and development and innovation. Also the firm’s market share will increase as more consumers that were not initially willing to pay the original price now demand the good or service. An additional advantage is that some consumers will benefit from lower prices.
However, other consumers that may require the product more will be forced to pay higher prices, which will lead to a decline in their consumer surplus and cause the firm to become allocatively inefficient as prices become greater than the marginal cost. Another disadvantage of price discrimination is that there may be administration costs that are incurred by the firm in separating the markets. Moreover, extra profits that discriminatory firms receive, may be used to finance predatory pricing so as to create further barriers to the entry of new companies along with increasing inefficiency of such firms due to the lack of competition.
Theories Applied to the UK Newspaper Industry
The national newspaper industry is widely seen to function in a monopolistically competitive market structure. Primarily, in a sense that the industry is concentrated by a large number of small firms, and also because the market produces a set of heterogeneous products, either through content or product branding. Furthermore, companies are assumed to be price makers, which can be seen through the price disparities that currently exist between newspapers.
Also, newspaper companies are aware that university students would be willing to purchase newspapers as it may help with their studies. Also more students would purchase newspapers if they were to be cheaper, conceivably due to budget constraints. Therefore newspapers such as The Guardian, The Independent and other leading broadsheets are able to sell newspapers at discriminatory prices in a way that they charge general consumers with common prices and lower prices to the students who may potentially demand the good but are not be willing to at the given common price. This method may be considered to be third-degree price discrimination, where ‘a firm divides consumers into different groups and charges a different price to consumers in different groups, but the same price to all consumers within a group’ (Sloman 1999:211). As a result of this modus operandi, newspapers will gain higher revenues and profits as they capture a new group of consumers, which will shift the demand curve to the right, thus leading to increases in prices and output.
Limitations of Monopolistic Competition and Price Discrimination in this Context
As I have shown above how these theories of market behaviour can be applied to the given situation, I will now also illustrate the limitations of these frameworks in the same setting, evaluating the extent to which these theories cannot act as suitable explanations of such behaviour.
To begin with, it may well be argued that the framework of monopolistic competition cannot be entirely applied to the newspaper industry because of the presence of barriers to entry toward new firms that result from evident start-up and sunk costs in addition to the existence of consumers’ predilections and preferences towards particular brands of newspapers.
With relation to the framework of price discrimination, it is argued that this theory can only be applied to a monopoly market structure, where a single firm can ascertain abnormal profits in the long-run and is able to charge different consumers different prices without any significant change in demand because there are no recognized alternatives. Newspaper companies wishing to price discriminate may be unable to do this given that there are other close substitutes that are present, which consumers may move to if discriminatory price techniques are deployed.
However Borenstein argues that ‘competition among heterogeneous brands and the absence of high entry barriers (seen in the newspaper industry) will almost never prevent price discrimination, even when they cause long-run profits to be driven to zero. In fact, when a usable sorting mechanism exists, a firm could be forced to discriminate to avoid losses when competing with other discriminating firms (Borenstein 1985: 380).
Furthermore, as I have mentioned above, one of the conditions for price discrimination is the prevention of the re-sale of the particular good or service. However, to a degree consumers are able to resell newspapers to other consumers as they are not immediately perishable goods. Therefore price discrimination may be prevented from being implemented in this setting, since university students that have been given discounts, have the ability to resell newspapers to other consumers that have been forced to pay higher (if not full) prices.
Conclusion
This essay has attempted to identify and discuss how the frameworks of monopolistic competition and price discrimination could explain the raison d'être for newspaper discounts being offered to university students. I have therefore endeavoured to examine theoretical and empirical evidence to explain the motivation of such newspaper companies to price discriminate as well as the ability of these firms to do so. Additionally, I have defined both theories and attempted to apply them to the given situation, citing both the similarities and the disparities.
As I have mentioned above, both frameworks of monopolistic competition and price discrimination can be applied to the practice of newspapers offering discounts to university student unions to a certain extent. However, I have also provided evidence of how it could be argued that either framework cannot be entirely applied to this situation.
Consequently, I have come to the conclusion that monopolistic competition is the framework that best captures the underlying principle of the given setting. I have selected this framework because it is evident that this market structure best explains the newspaper industry due to the following; the newspaper industry contains many firms each producing similar, but slightly differentiated products, each producer can set its price and quantity without affecting the marketplace as a whole, the market has a four-firm concentration ratio of less than 40%, which excludes it from being an oligopoly, newspaper companies are seen to keep prices relatively constant and contend through non-price competition measures such as marketing, advertising and branding and finally, rather than perfect competition, which has a perfectly elastic demand schedule, newspaper companies face a downward sloping demand curve, so firms can raise or lower prices to a degree without major shifts in demand.
Bibliography
BEGG, D, FISCHER, S and DORNBUSCH, R. (2000). ‘Economics’ (Sixth Edition), McGraw Hill
BLACK, J. (1997). ‘A Dictionary of Economics’, Oxford University Press
BORENSTEIN, S. (1985). ‘Price Discrimination in Free-Entry Markets’, The RAND Journal of Economics
CHAMBERLAIN, E. (1993). ‘The Theory of Monopolistic Competition’ (8th Edition), Cambridge, Harvard University Press
LIPSEY, R. G and CHRYSTAL, K. A. (1999). ‘Principles of Economics’ (Ninth Edition), Oxford University Press
SLOMAN, J. (1999). ‘Economics’ (Third Edition), Prentice Hall