Price discrimination and Welfare: 

The welfare effects of price discrimination can be decomposed into two separate effects. Price discrimination changes the distribution of output. Starting from a single price, prices rise for inelastic buyers (group 1) and fall for elastic buyers. This effect reduces welfare and consumer surplus, but increases profits. Moreover, consumer surplus falls by more than profits increase, so the net effect on welfare is negative. Net welfare the sum of profits and consumer surplus is the gains from trade. Price discrimination reduces the gains from trade, holding output constant, because maximizing the gains from trade requires selling at the same price in all markets. With two different prices, arbitrage would increase the gains from trade, resulting in a common price. Price discrimination represents a rearrangement of output away from high value buyers and toward buyers with lower values. The absence of price discrimination, which makes every buyer' s marginal value equal, creates the distribution of output that maximizes welfare. Price discrimination increases overall welfare only if the quantity rises by a sufficiently large amount. Consumer surplus is reduced in most cases - representing a loss of consumer welfare. For the majority of consumers, the price charged is significantly above marginal cost of production. Those consumers in segments of the market where demand is inelastic would probably prefer a return to uniform pricing by firms with monopoly power. Their welfare is reduced and monopoly pricing power is being exploited.

However some consumers who can buy the product at a lower price may benefit. Previously they may have been excluded from consuming it. Low-income consumers may be priced into the market if the supplier is willing and able to charge them a lower price. Good examples to use here might include legal and medical services where charges are dependent on income levels. Greater access to these services may yield external benefits (positive externalities) which then have implications for the overall level of social welfare and the equity with which scarce resources are allocated.