What is price discrimination?
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
What are the main aims of price discrimination?
What is the difference between price discrimination and product differentiation?
What are the main conditions necessary for price discrimination to work?
Here are the main conditions required for discriminatory pricing:
Differences in price elasticity of demand: There must be a different price elasticity of demand for each group of consumers. The firm is then able to charge a higher price to the group with a more price inelastic demand and a lower price to the group with a more elastic demand. By adopting such a strategy, the firm can increase total revenue and profits (i.e. achieve a higher level of producer surplus). To profit maximise, the firm will seek to set marginal revenue = to marginal cost in each separate (segmented) market.
Barriers to prevent consumers switching from one supplier to another: The firm must be able to prevent "consumer switching" – i.e. consumers who have purchased a product at a lower price are able to re-sell it to those consumers who would have otherwise paid the expensive price.
This can be done in a number of ways, – and is probably easier to achieve with the provision of a unique service such as a haircut, dental treatment or a consultation with a doctor rather than with the exchange of tangible goods such as a meal in a restaurant.
Price discrimination is easier when there are separate and distinct markets for a firm's products and when price elasticity of demand varies from one group of consumers to another
Summary of the main conditions
What is 1st degree (perfect) price discrimination?
Perfect Price Discrimination is charging whatever the market will bear
In reality, most suppliers and consumers prefer to work with price lists and menus from which trade can take place rather than having to negotiate a price for each unit bought and sold.
What is Second Degree Price Discrimination?
Early-bird discounts – generating extra cash flow for a business
Customers booking early with airline carriers such as EasyJet or RyanAir will normally find lower prices if they are prepared to book early. This gives the airline the advantage of knowing how full their flights are likely to be and is a source of cash flow prior to the flight taking off.
Closer to the time of the scheduled service the price rises, on the justification that consumer's demand for a flight becomes inelastic. People who book late often regard travel to their intended destination as a necessity and they are likely to be willing and able to pay a much higher price.
Peak and Off-Peak Pricing