Price discrimination means charging different consumers different prices for the same good.
First-degree price discrimination means every consumer faces a different price.
Second-degree price discrimination means consumers may get discounts for buying different amounts of the good; in other words, bulk-buying.
Third-degree price discrimination means different consumer groups face different prices for the same good. This could include discounts for students or pensioners for example or peak versus off-peak pricing.
Examples
Cinemas charge different prices for example Cineworld charges lower price to seniors, students and children compared to the price for adults.
Rail tickets – Student Railcards can offer a discount on trains.
Uber – at different times of day, there are different prices for Uber rides. There are also different prices for different qualities of vehicle (e.g. Uber Lux).
Apple – offers slightly different prices on some goods e.g. Macbooks to consumers in different countries.
Conditions necessary for price discrimination
To be able to conduct price discrimination, the following conditions need to be met:
- There are at least two groups with different price elasticities of demand.
- These groups can be separated. The firm can tell which consumers belong to which group and can prevent consumers pretending to be part of another group.
- The firm is a price maker, so they are able to charge different prices to different groups.
- Low administration and enforcement costs. Otherwise if these costs are high, then price discrimination could harm the firm’s profit overall.
Diagram
This diagram below shows the case of third-degree price discrimination.
The left diagram shows the whole market. We assume the firm is a price maker, so marginal revenue and average revenue are downward sloping. We also assume constant marginal costs for simplicitly.
The left diagram shows the whole market. The firm maximises profit and sets quantity where MR=MC and so produces at price p1. This gives the price if the firm did not price-discriminate and is drawn over the other diagrams in red for comparison.
The middle diagram shows the group with the more elastic price elasticity of demand, so MR and AR are flatter. For example this could be the peak travel group in the case of on-peak, off-peak train tickets. These people could be more flexible about when they travel. In this case to maximise profits, the firm produces quantity q2 and price p2. This price is below the original price p1 when there is no price discrimination. So the elastic group is better off under price discrimination – they face a lower price and higher consumer surplus.
The right diagram shows the group with the more inelastic price elasticity of demand, so MR and AR are steeper. This could be the off-peak travel group in the case of train tickets. These people may be commuters and may be less flexible about when they can travel – they may need to get to work. Again to maximise profits, the firm produces quantity q3 at price p3. The new price with price discrimination is above the original price p1 under no price discrimination. This group is worse off under price discrimination, with a higher price and lower consumer surplus.
Advantages
- Higher profits for firms. For the elastic group, lowering the price leads to higher revenues and profits (given constant marginal costs). For the inelastic group, raising the price will increase profits.
- More price-elastic group benefits from lower prices and sees higher consumer surplus.
- Higher profits could be reinvested into company to improve research and development and quality of product, benefitting consumers.
- The profits may also be used to support (“cross-subsidise”) loss-making parts of your company e.g. rural bus routes, benefitting even more people.
- If the poorer group has the more elastic PED, then price discrimination could reduce inequality.
- May help manage capacity. For example charging more for peak train use may lead to less overcrowding in trains at peak times, as some consumers switch to other off-peak travel times.
Disadvantages
- More price-inelastic group sees higher prices and reduced consumer surplus.
- The firm incurs costs from price discrimination from adminstration. Price discrimination may lower firms’ profits if administrative costs are too high.
- May be difficult in practice to prevent “seepage” – consumers can pretend to be part of another group to get a discount e.g. a student discount.
Other evaluation points
- The benefits of price discrimination depend on whether the necessary conditions hold.
- The impact on inequality depends on whether the group with more elastic PED is the poorer or the richer group.
- The benefit of higher profits depends on how those profits are used. Profits could go to dividends instead of investment. For Apple for example, roughly 25% of their profits go out as dividends.
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