Price discrimination Flashcards
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
Price discrimination in action
- Market haggling
- Cinema ticket prices
- Mobile phone contracts/ tariffs
- Hairdresser discounts
- Taxi fares at peak times of the day
- Educational bursaries
Dynamic pricing
1st degree
- Charging different prices for each individual unit purchased - e.g. people pay their own individual willingness to pay
2nd degree
- Price varying by quantity sold e.g. bulk purchase discounts
- Prices varying by time of purchase e.g. peak time prices
3rd degree
- Charing different prices to different groups of consumers segmented by PED, income, age and sex
Aims of price discrimination
- Extra revenue
- Higher profits
- Improved cash flow
- Use up spare capacity
> Providing that extra units of a good or service can be sold for a price above the marginal cost of supply, price discrimination in an effective way to increase revenues and profits
> Price discrimination takes us away from the standard assumptions in theory of the firm that there is a single profit-maximising price for the same good or service
Conditions for price discrimination
Firms must have sufficient monopoly power
- Monopolistic always have pricing power - e.g. price makers not takers
Identifying different market segments
- E.g. groups of consumers with different PED
Ability to separate different groups
- Requires information/ sufficient market intelligence on purchasing behaviour of consumers
Ability to prevent re-sale (arbitrage)
- No secondary markets where arbitrage can take place at intermediate prices e.g. limited sales, age restrictions, ID cards
1st degree discrimination
- Sometimes known as optimal pricing or perfect price discrimination
- 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
- Examples:
> Housing market
> Second hand car dealers
> Antique auctions
2nd degree price discrimination
- Second degree price discrimination occurs when different prices are charges based on the quantity demanded
- There is more than one group of consumers in the market and the firm is able to price discriminate by changing lower prices to those groups that are willing to buy more
- This is also called block pricing
- A firm finds it difficult to identify the different groups of consumers so it will give different discounts on the size of the order. The greater the bulk buying the higher the discount
- The firm is able to extract some, but not all, of the consumer surplus available
- Examples:
> Selling blocks of tickets/ products in larger quantities
> Getting rid of excess inventories/ socks when demand is low
> Standby tickets for hotels, theatres, flights
> Peak and off-peak pricing schemes e.g. travel
3rd degree price discrimination
- Most frequent form of price discrimination and involves charging different prices for the same product in different segments of the market
- The key is that 3rd 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
- Third degree price discrimination occurs when the firm identifies groups of consumers with similar characteristics
- The firm can then segment the market based in these characteristics e.g. sex, age and geography
- The firm will charge different prices dependant on the different elasticities of demand
- Those groups that are more price inelastic will be charged higher prices
- This different from 2nd degree PD as it is based on identifying market segments rather than the quantity demanded
Advantages of price discrimination
- Firms will be able to increase revenue. This will enable some firms to stay in business who otherwise would have made a loss. E.g. PD is important for train companies who offer different prices for peak and off peak
- Increased revenues can be used for research and development which benefit consumers
- Some consumers will benefit from lower fares E.g. older people have discounted fares on buses
Disadvantages of price discrimination
- Some consumers will end up paying higher prices. These higher prices are likely to be allocatively inefficient because P>MC
- Decline in consumer surplus
- Those who pay higher prices may not be the poorest E.g. adults can be unemployed and OAPs could be well off
- There may be administration costs in separating the market
- Profits from price discrimination could be used to finance predatory pricing
Benefits of price discrimination
- Cheaper for certain groups
- Higher profits
- Use up spare capacity
- Higher revenue
- Better cash flow
- Creates equity in some cases if higher income pays more
Drawbacks of price discrimination
- Higher prices
- More expensive for some groups
- Consumer dissatisfaction
- More monopoly power so fewer substitutes
