Price discrimination is the practice of charging prices for the same or similar product or service to different consumers. The price differences do not reflect the differences in cost of supply
There are three types of Price Discrimination
- First Degree: This involves charging consumers the maximum price that they are willing to pay. There will be no consumer surplus
- Second Degree: This involves charging different price depending upon quantity consumed e.g. after 10 minutes phone calls become cheaper
- Third Degree: This involves charging different prices to different types of consumers e.g. students and off peak travellers.
There are 3 necessary conditions for a firm to be able to price discriminate:
The firm has the market power to set its own prices. As a result that film most operate under imperfect competition market structure i.e. a monopoly has the power to set its own prices, because of barriers to entry and no competition allows the firm to have control of what it does. Monopoly products are perfect differentiated with no substitutes, if the consumers want the product, they have no choice but to pay for the price that is set.
The firm must be able to separate the market and prevent resale e.g. stopping an adult using a Child’s ticket. This is to prevent being bought for a cheaper price and being resold for a higher/lower price.
Barriers between markets may be:
- Geographical regions: Consumers can be separated by distance e.g. the international dumping of cheap goods, where goods are sold overseas at price below those in the home market, and often below the cost of production.
- Temporal: Customers are separated by time e.g. it may be cheaper for a consumers to buy a book after 8 to 12 month of release in paperback than buying the same book in hardcover in the early period of it being released.
- Consumer type: Consumers are separated according to some easily identified feature e.g. age, sex, income or occupation; examples of this would include theatre tickets, rail travel for students and higher price physical consultation fees for those who are perceived as being able to pay more
The two conditions that have been discussed so far would make price discrimination possible but for it to be profitable the third condition is identified
There must be consumers with different elastic of demands. This is obvious, it all consumers have the same elasticity of demand then it will be inefficient for the firm to price discriminate since all the consumers will only pay for one uniform price. We have full time student that typically have low incomes and full time adult with higher income. Therefore, for a group like adults have Price Elasticity Demand PED is inelastic – firm may set prices higher for an adult since they are more likely earn higher income. On the other hand a student may have Price Elasticity Demand in elastic as they are more likely to earn lower income.
Advantages of Price Discrimination
Firms will be able to increase revenue. This will enable firms to stay in business for example by offering different prices in peak and off peak periods. Firm will be able to attract more consumers offering lower prices during off peak period enabling the firm to stay in business
Some consumers may object to price discrimination especially those consumers that have to pay higher prices. Users of peak transport may argue that price discrimination represent a transfer of welfare from consumers to producers through extraction of consumers surplus (firms set prices according to consumers reservation prices), in a way in which producers gain at the expense of the consumers trough extraction of consumers surplus. In the extreme case of a first degree price discrimination, no consumers receives any consumer surplus.
First Degree Prices: Extracting all consumers surplus
In the first degree price discrimination we assume that all consumers have a reservation price at which it is the maximum price at which they are willing to pay. If the firm set a price above consumers’ willingness to pay or demand function, the consumers will abstain from buying altogether. It is useful to see consumers arrayed along the horizontal axis in figure 12.1.
In a standard case, where a monopolist charge consumers a profit maximisation price at the reservation price of (Pm, Qm) Notice that the monopolist did not charge the same price to all consumers. They charged other consumers to the right of Qm at a lower price and eliminating any deadweight losses by charging consumer prices by their reservation prices.
Montary Gain: There is some montary gain on the consumers behalf dispite the exploitation of consumers surplus. Consumers can still purchase the same product but for a price that acceptable to them. A price they are willing to pay for or can afford to pay.