Professor William Baumol shows how regulators can be misled by oversimplified economic theory. For example, it is generally recognized that perfect competition is an artificial construct that rarely is approximated in reality. Yet it is sometimes treated as an appropriate guide to regulators, threatening to yield damaging rules. For example, since discriminatory pricing is incompatible with perfect competition, such prices are said to prove monopoly power. Yet many markets with discriminatory prices are very competitive. Baumol shows that effective competition does not impose uniform prices and demonstrates a stronger result: Where competitive pressures prevail, they can force all firms to adopt discriminatory prices if consumer arbitrage is difficult. This radically different picture of competitive markets helps to explain the near ubiquity of discriminatory pricing in reality and indicates limits to the use of discriminatory pricing as a justification for regulatory intervention.

Joint Center for Regulatory Studies