There is widespread agreement that price deregulation promotes competition and should therefore be favoured in most industries. Over the past decade, governments in the US and EU member states have largely relinquished their powers to enforce `mill pricing' to prohibit firms from discriminating on price between spatially separated consumers. Firms' ability to cut prices in one part of the market without changing prices elsewhere effectively reduces their power to commit to any set of prices which strengthens price competition. In Discussion Paper No. 972, George Norman and Jacques-François Thisse argue that fiercer price competition need not benefit consumers, however: for a given degree of product variety, stronger price competition will reduce the prices charged by incumbent firms, but it may also benefit these firms by deterring entry. Norman and Thisse show that the latter effect dominates: discriminatory pricing reduces product variety relative to mill pricing.

Free entry is unlikely to lead to the socially optimal degree of product variety, however, and the relative welfare effects of discriminatory and mill pricing largely depend on firms' relocation costs. If these are low, free entry always gives too much product variety, but discriminatory pricing may mitigate this effect and enhance the consumer surplus by deterring entry. Very high relocation costs may restrict product proliferation excessively and will always do so when firms can discriminate on price, since the entry deterrence effect primarily serves to raise the profits of incumbent firms (both individually and in the aggregate) at consumers' expense. Norman and Thisse conclude that price deregulation that allows firms to discriminate on price is most likely to benefit consumers when it is easier for firms to change a product's location ex post. Price regulation is therefore more likely to be needed when relocation costs are fairly high, which is easily verifiable by antitrust and similar regulatory bodies.

Product Variety and Welfare under Discriminatory and Mill Pricing Policies
George Norman and Jacques-François Thisse

Discussion Paper No. 972, June 1994 (IO)