Third-degree price discrimination and moral hazard

Abstract

Literature on monopolistic third-degree price discrimination stresses that discriminatory pricing only leads to a welfare gain if total output increases. In many circumstances, this will not occur. Thus, uniform pricing has some appeal from a welfare point of view. In this paper, I analyze whether the welfare comparison of different price regimes changes if moral hazard is taken into account. I show that this, indeed, is the case. If goods are subsidized, it is possible that welfare under third-degree price discrimination is above welfare under uniform pricing, even though output has not increased. The finding of this paper appears to be relevant for the pharmaceutical market for two reasons. First, monopolistic pricing is important in this market, as production requires prices above marginal costs to cover the costs of R&D. Second, pharmaceutical markets are subject to moral hazard since consumers due to insurance coverage only pay a fraction of the actual price.