Price Discrimination

Question 1

Briefly, what is price discrimination?

Answer 1

Price discrimination is a practice used by firms to charge certain consumers a higher price than others for an identical good or service, all in order to profit maximise.

Question 2

What is first degree price discrimination?

Answer 2

First degree price discrimination is where firm sells each unit at the maximum price which the consumer is willing to pay. (It tries to find the maximum consumer surplus to maximise profits)

Question 3

What problems to firms face with first degree price discrimination?

Answer 3

They will try to charge the full consumer surplus for each individual consumer yet they will never actually know the price which they are willing to pay.

Question 4

What is second degree price discrimination?

Answer 4

It is where the firm charges the consumer a certain amount for their first unit, but a smaller amount of the next unit and the next unit etc…

For example, a waffle costs £1 for one waffle or you can buy two waffles for £1.50.

Second degree price discrimination is not common in transport.

Question 5

What difference is there for the consumer between first degree and second degree price discrimination?

Answer 5

In second degree price discrimination the consumer is always aware what the costs of the unit will be.

Question 6

What is third degree price discrimination?

Answer 6

This is where firms divide different customer groups into different segments and charges each group a different price for the same product. It takes into account the different demand curves the consumers from the segment have.

It is the most common form of price discrimination.

Question 7

What different segments can firms split consumers up into for third degree price discrimination?

Answer 7

1. Time (peak/off-peak)
2. Geographical location
3. Age
4. Student status

Question 8

What problems do firms face dividing their consumers into lots of different groups?

Answer 8

It can be very costly for firms to split their customers into lots of different groups.

Question 9

What do firms need in order to successfully use third degree price discrimination?

Answer 9

1. The firm must have a good knowledge of its market
2. The firm needs to have market power
3. Segmented consumer types

Question 10

What effect does arbitrage have on third degree price discrimination?

Answer 10

If consumers who are eligible for cheaper tickets resell them onto those who should be paying more then the firm is missing out on revenue.

By making products non-transferrable this can be resolved.

Items which are immediately consumed and are non-transferrable such as airline tickets and electricity don’t suffer from arbitrage.

Question 11

How does an airline try to use price discrimination?

Answer 11

1. Airline ticket pricing techniques are a perfect example of first degree price discrimination, it will try to get the maximum amount of consumer surplus.
2. They are able to prevent arbitrage by making tickets non-transferrable.
3. An airline will judge how many seats to release into each fare category by analysing previous consumer data.
4. Airlines are often close at practicing perfect price discrimination but they will never be able to actually obtain the perfect price discrimination