Abstract
A well-known result with important policy implications is that an output increase is a necessary condition for social welfare to increase with third-degree price discrimination. In this paper, we explore the robustness of this result to the introduction of an assumption that is different than the conventional approach, namely preferences not being quasilinear. We show that in the presence of income differences among consumers, the aggregate utility of consumers may increase with price discrimination while total output remains constant. This result questions the general policy recommendation that third-degree price discrimination should be disapproved because it reduces welfare unless output increases. Our result highlights the crucial role of the assumption of quasilinear preferences in standard welfare calculations. In the presence of income differences, consumer surplus may be a biased welfare measure, thus potentially leading to incorrect conclusions when assessing the impact of specific policies.
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Notes
Notice further that various theoretical analyses have been based upon the condition that the incremental consumer’s surplus is independent of the consumer’s income. See, for instance, Willig (1978). Also Foster and Neuburger (1974) address the problems with the behavior of the marginal utility of money. They actually refer to the fact that: “Marshall originally developed his consumer surplus as a measure of cardinal utility. In order to do this he required the condition of constant marginal utility of money. Thus, for him the measure was never anything but a good approximation”.
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We thank the Editor, Menahem Spiegel, and an anonymous referee for their suggestions, which substantially improved the quality of the paper. Mendi gratefully acknowledges financial support from Fundación Ramón Areces. All errors are our own.
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Galera, F., Garcia-del-Barrio, P. & Mendi, P. Consumer surplus bias and the welfare effects of price discrimination. J Regul Econ 55, 33–45 (2019). https://doi.org/10.1007/s11149-019-09376-x
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DOI: https://doi.org/10.1007/s11149-019-09376-x