Price Discrimination and Social Welfare with Demand Uncertainty

Abstract

Price, output and welfare erects of third-degree price discrimination is analyzed in the context of a risk-averse monopolist, who commits to xed prices before the revelation of random and potentially correlated demands. Assuming the disturbance term to be additive, white noise and the monopolist to have a quadratic (mean-variance) utility function, we show that price discrimination may occur with identical expected demands, the relatively risky but price insensitive market may be charged the lower price and despite linear demands, aggregate expected output may fall while social welfare rises. All of these results, which run counter to those in the deterministic model, are shown to be driven by the asymmetry in the revenue and risk characteristics of the markets and the willingness of the monopolist to trade increased level for reduced risk of expected prot in a manner similar to portfolio choice with risky and correlated assets. Key Words: Monopoly (D42), Monopolization Strategies (L12), Decision Making under Risk and Uncertainty (D81)