A recent newspaper article commented on the fact that a pharmaceutical company charged customers in the United States (US) US$800 per treatment whilst it charged customers in Egypt US$80 for the same treatment.
(a) Explain why the company might follow this policy and what conditions are necessary to allow the policy to be successful.[12]

An explanation of price discrimination – marginal revenue (MR) differs between markets with the same marginal cost (MC).
Firms often find themselves in a situation where they can increase profits by selling the same product at different prices.
Such a practice is known as price discrimination for it allows the firm to charge different price for the same product to different consumers when the price difference is not justified by differences in costs of production.
However, if price differences are due to differences in a firm’s costs of production, then they do not qualify as ’price discrimination’.


Explain why the company might follow price discrimination.

The objective of practicing price discrimination is to increase company’s profit by appropriating consumer surplus.


Explanation of the conditions necessary for its successful implementation,
Price maker

The comment in the article suggests that the pharmaceutical company practiced price discrimination for it charged different prices in two different countries for the same treatment.
This signifies that the company must have some degree of market power, or some ability to control price.

In other words, it must be facing a downward-sloping demand curve that allowed the company to set different prices for the same treatment in both the US and Egyptian markets because price discrimination can occur in all market structures except perfect competition.

A perfectly competitive firm can sell any amount of output at the single price determined in the market; if it increases price to some customers, it will lose them to different sellers: and it would have no reason to lower price for some customers since it can sell its entire output at the market price.
Therefore, the perfectly competitive firm has no possibility of charging different prices for the same good.

Barriers between markets

A price-discriminating firm must ensure that it is not possible or at least is very difficult and costly for any consumer to buy at the low price and resell at the higher price, if resale were possible or easy, consumers would avoid purchasing from the higher price firm, and would try to buy the product from other consumers who had bought at the lower price.
In this case, resale of treatment is impossible due to the nature of the product.
Moreover, the distance between the US and Egypt must have involved a relatively higher travelling cost than the price difference.
Hence it might have made it possible for the company to charge differently in different countries for the travelling cost must have eliminated any incentive for the patients in US to travel to Egypt in order to reduce their cost of treatment.

Differing price elasticity of demand
Price discrimination is possible only when consumers have different price elasticities of demand (PEDs) for the good.
This is because consumers with a relatively low PED will be willing to pay higher price for a good than consumers with a relatively higher PED.