Welfare and price discrimination : optimal departures from uniform pricing

Abstract

It is tempting - and I shall not resist the temptation, as my subtitle suggests - to start with a plagiarism. Baumol and Bradford and their famous 1970 paper on "Optimal Departures from Parginal Cost Pricing" are the victims. The need for the present paper is, indeed, a paradox in itself and it might be subtitled : The Purloined Proposition or the Mystery of the Mislaid Maxim. For the results which it describes have appeared many times in the literature and have been reported by most eminent economists in very prominent journals. Yet these results may well corne as a surprise to many readers who will consider them to be at variance with ideas which they have long accepted. The proposition in question asserts that,generally, discriminatory prices will be required for an optimal allocation of resources in real life situations. The reason for the difficulty into which uniform pricing is likely to fall is that real life firms do have at least some monopoly power and can use marketing techniques to keep their markets separate, so that price discrimination is generally possible. This fact of life is not well known, nor is it widely recognized that there exists a highly sophisticated and well-developed - though recent - body of literature indicating what should be done in such circumstances. The discussion of this paper differs from the earlier writings in several ways. First, instead of considering regulatory public utility pricing, it explores parallel developments in the framework of a private economy with profit maximizing firms. Second, it attempts a simplified exposition which is, of course, possible only at a cost in terms of loss of generality. Third, it brings together, explicitly ail three strands of the discussion : the welfare theoretic, the regulatory, and the industrial organization contributions. Finally, as far as I know, it offers the first overview of the extensive literature that has grown up in the area.