Price discrimination is the practice of charging a different price for the same good or service. There are three types of price discrimination —
- first-degree,
- second-degree, and
- third-degree price discrimination.
Discrimination, alternatively known as perfect price discrimination, occurs when a firm charges a different price for every unit consumed.
The firm is able to charge the maximum possible price for each unit which enables the firm to capture all available consumer surplus for itself. In practice, first-degree discrimination is rare.
A monopolist may be able to engage in a policy of price discrimination. This occurs when a firm charges a different price to different groups of consumers for an identical good or service, for reasons not associated with the costs of production. It is important to stress that charging different prices for similar goods is not price discrimination. For example, price discrimination does not occur when a rail company charges a higher price for a first class seat. This is because the price premium over a second-class seat can be explained by differences in the cost of providing the service.
CONDITIONS REQUIRED FOR PRICE DISCRIMINATION TO WORK
There are basically three main conditions required for price discrimination to take place.
Monopoly power: Firms must have some price setting power – so we don’t see price discrimination in perfectly competitive markets.
The elasticity of demand: There must be a different price elasticity of demand for the product from each group of consumers. This allows the firm to extract consumer surplus by varying the price leading to additional revenue and profit.
Separation of the market: The firm must be able to split the market into different sub-groups of consumers and then prevent the good or service being resold between consumers. (For example, a rail operator must make it impossible for someone paying a “cheap fare” to resell to someone expected to pay a higher fare. This is easier in the provision of services rather than goods.
The costs of separating the market and selling to different sub-groups (or market segments) must not be prohibitive.
EXAMPLES OF PRICE DISCRIMINATION
There are numerous good examples of discriminatory pricing policies. We must be careful to distinguish between discrimination (based on consumer’s willingness to pay) and product differentiation – where price differences might also reflect a different quality or standard of service.
Some examples worth considering include:
- Cinemas and theaters cutting prices to attract younger and older audiences
- Student discounts for rail travel, restaurant meals and holidays
- Car rental firms cutting prices on weekends
- Hotels offering cheap weekend breaks and winter discounts.
