Living Economics

Most sellers of differentiated products¹ are faced with a downward-sloping demand curve. Because their competitors do not sell perfect substitute products, they still have some power to search for the single profit-maximizing price. In other words, they don't have to worry about wholesale defection of all their customers by charging higher prices or being inundated with defecting customers from competitors by charging lower prices. But the same price must be applied to all units sold at any price level. In other words, a lower price needed to sell just one more unit must be offered for all the previous units sold at a higher price. Such sellers are known as single-pricing price searchers.

But if there is only one seller for a unique product, the single seller can charge a different maximum price each buyer is willing to pay without fearing any customer defection. This pricing strategy would work if the buyer paying a lower price cannot resell the product for a profit to the buyer willing to pay a higher price. Such sellers are known as perfect price discriminators.

At the other extreme, the product may be so homogenous that buyers cannot tell the difference between sellers. Such products are known as commodities. Here, buyers care only about price and nothing else. Because any price difference between sellers would lead to massive migration of customers, only one uniform single price can prevail across sellers at any one time. Such sellers must accept the prevailing price as given and are thus known as price takers.

Regardless of product uniqueness and the consequent pricing power, all sellers will maximize profit at the output level where the additional revenue from selling one more unit (i.e., MR for marginal revenue) is equal to the additional cost of producing that unit (i.e., MC for marginal cost).

But the output level will be very different. Because price (P) is always equal to marginal revenue (MR) for price takers (due to absence of market power) and the perfect price discriminator (due to sheer market power), P = MC when MR = MC. When P = MC, output is at the socially efficient level because the marginal benefit to the buyer is equal to the marginal cost of producing that unit.

For the price searcher, however, P > MR because a lower price needed to sell just one more unit must be offered for all the previous units sold at a higher price. As a result, when the single-price searcher maximizes profit by equating MR with MC, P > MC. This maximum-profit output is always lower than the maximum-efficiency output where price (i.e., marginal benefit to the last buyer) is lowered to the level of MC.

Not only is the maximum-profit output level different among the price searcher, the price discriminator, and the price taker, the profit size is also very different. The perfect price discriminator will always have the highest total profit because he is selling each unit at the maximum price the buyer is willing to pay (i.e., reservation price). The price searcher will have lower total profit because every buyer is charged the same single price regardless of his reservation price. The price taker will have zero profit because any positive profit will attract additional competitors.

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