Price Discrimination

A2 Microeconomics

Price discrimination occurs when a business charges a different price to different groups of consumers for the same good or service, for reasons not associated with costs.

Price Discrimination

Two main conditions required for price discrimination to work

Differences in price elasticity of demand:• Charge a higher price to group with low PED• Charge lower price to consumers with a more

price elastic demand

Prevent resale / consumer switching• Easier with services than goods• Time limits – product bought at certain time• Photo cards / identification systems• Electronic / digital ways of protecting usage

Types of Price Discrimination

1. Third-degree price discrimination occurs when different prices are charged to groups of buyers in totally separate markets.

2. First-degree price discrimination occurs when each unit of output is sold at a different price such that all consumer surpluses go to the seller.

3. Second-degree price discrimination occurs when the seller prices the first block of output at a higher price than subsequent blocks of output.

4. The hurdle method of price discrimination exists when the seller offers a lower price, coupled with an inconvenience that rich consumers prefer to avoid.

Find price discrimination here!

1st Degree Discrimination

Sometimes known as optimal pricing

The firm separates the market into each individual consumer and charges them the price they are willing and able to pay.

If successful, the business can extract the entire consumer surplus that lies underneath the demand curve and turn it into extra revenue or producer surplus

1st Degree DiscriminationPrice, Cost

Output (Q)

Marginal Cost

MR

AR

P1

Q1

Normal profit maximising price where MR=MC – output sold at a uniform price P1

£20

1st Degree DiscriminationPrice, Cost

Output (Q)

Marginal Cost

MR

AR

P1

Q1

Extra revenue and profit to be made from pricing according to willingness & ability to pay

£20

1st Degree DiscriminationPrice, Cost

Output (Q)

Marginal Cost

MR

AR

P1

Q1

If the market can be split up – final output will be higher at Q2

Aim is to draw from each consumer what they can pay for the product

Q2

£20

2nd Degree Price DiscriminationSelling blocks of tickets / products in larger quantities

Getting rid of excess inventories / stocks when demand is low

Standby tickets for hotels, theatres, flights etc

Peak and off-peak pricing schemes e.g. travel, telecommunications

3rd Degree Discrimination

Most frequently found form of price discrimination and involves charging different prices for the same product in different segments of the market.

The key is that third degree discrimination is linked directly to consumers’ willingness and ability to pay for a good or service.

It means that the prices charged may bear little or no relation to the cost of production

3rd degree discriminationPrice

Output (Q)

MC

MRAR

Price

Output (Q)

MC

MR

AR

Low Ped

High Ped – consumer are price sensitive

3rd degree discriminationPrice

Output (Q)

MC

MRAR

Price

Output (Q)

MC

MR

AR

Q1

P1

3rd degree discriminationPrice

Output (Q)

MC

MRAR

Price

Output (Q)

MC

MR

AR

Q1

P1

P2

Q2

High Ped – low profit maximising price

3rd degree discriminationPrice

Output (Q)

MC

MRAR

Price

Output (Q)

MC

MR

AR

Q1

P1

P2

Q2

P2

Price P2 would keep this group out

of the market

Pricing to segment the market

Two-Part Pricing PoliciesA fixed fee is charged + a “variable” charge based on units consumed• Fixed fee may be set up charge• Designed to cover fixed costs of supply

Examples:• Taxi fares• Amusement park charges• Mobile phone tariffs

Mobile Phone Tariffs in Action

The Freemium ModelA business model where in you give away a core product for free and then generate revenue by selling premium products to a small percentage of free users

Evaluation Question

Evaluate the view that a strategy of price discrimination by a producer always works more in the interests of producers rather than consumers and society as a whole

Welfare gains for consumers?Potential for cross subsidy of activities that bring wider social benefits

Making better use of spare capacity – helps to keep businesses in business

Bringing some new consumers into market – otherwise excluded by price

Use of monopoly profit for research – a stimulus to innovation in long-run

Some counter argumentsExploitation of the consumer – majority still pay > marginal cost causing loss of allocative efficiency

Extraction of consumer surplus turned into higher producer surplus / supernormal monopoly profit

Possible use as a predatory pricing tactic / and barrier to entry / might cause trade tensions

Reinforces the monopoly power / dominance of existing firms which is not in long run interest of consumers (higher prices eventually)

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