Price Discrimination

Question 1

what is 1st degree price discrimination?

Answer 1

This is where the firm charges the maximum price that a consumer is willing to pay. This is very difficult in practice.

Question 2

what is 2nd degree price discrimination?

Answer 2

This is when consumers are charged different prices according to how much they consume. For example, units of electricity become cheaper after higher levels of consumption.

Question 3

what is 3rd degree price discrimination?

Answer 3

This is when consumers are grouped into two or more independent markets. For example, train companies offer discounts for people over 65 and to people travelling off-peak and student discounts.

Question 4

What are the conditions necessary for price discrimination?

Answer 4

1.The firm must be a price maker, i.e. able to set prices.
Price discrimination can only occur in imperfect competition (oligopoly or monopoly).
2.The firm must be able to separate the market into different sections and prevent resale, e.g. it must be impossible for an adult to use a child’s ticket.
3.There must be a different elasticity of demand for the different market sections, e.g. train firms can charge high prices at peak times because, in this period, demand for train travel is inelastic.
4.The cost of separating markets must be less than extra revenue gained.
5.It usually requires low or constant marginal cost

PRICE DISCRIMINATION DIAGRAM

Question 5

Price Discrimination pros and cons

Answer 5

Pros:

1.Firm will be able to increase revenue. This may enable some firms, who may have otherwise have made a loss to stay in business,e.g. train companies need price discrimination to offer off-peak travel.
2.Research & development. Increased revenue can be used for research and development, which leads to better products for consumers.
3.Cheaper prices. Some consumers, often on lower incomes, will benefit from lower fares,e.g. pensioners can take advantage of cheaper fares on
trains.

Cons:

1.
Higher prices. Some consumers will face higher prices, leading to allocative inefficiency and a loss of consumer surplus.
2.Inequality. Often those who benefit from lower prices may not be the poorest. For example, some old people may be quite rich, but the unemployed will have to pay the full adult fare.
3.Administration costs involved in separating the markets and implementing different prices