In the discriminating monopoly different prices are charged by the monopolist. But the question is how a monopolist decides the out put to be produced and how he sets different prices of the commodity under price discrimination.
First of all monopolist divides his total market into sub-markets.We can explain this concept by assuming that there are only two markets Multan and Karachi. In the Multan market the elasticity of demand for the product of monopolists is low and in market of Karachi it is high. The discriminating monopolist will sell a greater quantity of his product by making a price reduction in market of Karachi. He sells lesser commodity in Multan market at a higher price than the Karachi market. The monopolist will then earn maximum profit by price discriminating as it is explained by the following diagram.
CMR = Combined market revenue.
EXPLANATION :- In these diagrams we see that the monopolist has divided his total market into two sub-markets, Elasticity of demand is greater in Karachi market than the Multan markets. In Multan and Karachi markets AR curve shows the average curve.Combined marginal revenue ( CMR ) has been obtained by MR and MRC. MC is the marginal cost curve.In a discrimination monopolist is in equilibrium position at out put at which MR = MC curve cuts the MR curve from below.According to the third diagram OQ3 out put will be divided between the two markets in such a way that MR of each market will be equal to EQ3. Any how in Multan market the price charges are higher as compared to the Karachi market because the Multan market elasticity of demand is less than the Karachi market. Following two conditions must be satisfied for the equilibrium.
1. MC of Total out put = CMR ( Combined Marginal Revenue )
MR in Multan market = MR in Karachi market = CMR
MR = Marginal Revenue MC = Marginal Cost.