Q&A - What is price discrimination and why do businesses use it?

In contrast to predatory pricing, price discrimination is perfectly legal and very common. It involves charging a different price to different groups of people for the same product.

The basic objective of price discrimination is that, by setting different prices for the same product in different markets / segments, a business can increase its total sales revenues.

You’ll see lots of examples of price discrimination in action. For example:

• Student and senior citizen discounts, off peak fares cheaper than peak fares
• In the airline and hotel industries, spare seats and rooms are sold at the last minute at greatly reduced prices (price discrimination used to sell off spare capacity)
• Reduced prices for cinemas and theatres in the afternoons

Two things need to happen for a business to use price discrimination:

(1) 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.

(2) Barriers to prevent consumers switching from one supplier to another: The business must be able to prevent “consumer switching” – a process whereby 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.

Examples of price discrimination:

Early-bird discounts

If you are looking for a bargain flight with a low-cost airline, booking early with carriers such as EasyJet or RyanAir will normally mean lower prices. 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

Peak and off-peak pricing and is common in the telecommunications industry, leisure retailing and in the travel sector. For example, telephone and electricity companies separate markets by time: There are three rates for telephone calls: a daytime peak rate, and an off peak evening rate and a cheaper weekend rate. Electricity suppliers also offer cheaper off-peak electricity during the night.

At off-peak times, there is plenty of spare capacity whereas at peak times when demand is high and supplier may experience capacity constraints.