Price Discrimination

Question 1

Price Discrimination means charging Different Prices for the Same Product

Answer 1

1. Price discrimination occurs when a seller charges different prices to different customers for exactly the same product.
   - it’s not price discrimination if the products aren’t exactly the same
   - so Business-class and Standard-class plane tickets are not an example of price discrimination, since it costs more to provide the comfier seats and extra legroom in Business class.

Question 2

Several Conditions need to be satisfied for a firm to make use of price discrimination

Answer 2

• The seller must have some price-making power (e.. there might be barriers to entry preventing competition). So monopolies (an oligopolies) can price discriminate.
• The firm must be able to preven seepage - it must be able to prevent customers who have bought a product at a low price re-selling it themselves at a higher price to customers who could have been charged more.

Examples:

1. Theatres and cinemas offer ‘concession’ prices for certain groups
2. Window cleaners could charge more in a smart neighbourhood than in a lower-income area.
3. Train tickets at rush hour cost more than the same train ticket at other times of the day
4. Pharmeceutical drugs may be sold at difference prices in different countries.

Question 3

Price discrimination transfers Consumer Surplus from Consumer to Producer

Answer 3

1. A consumer surplus is the difference between the actual selling price of a product and the price a consumer would be willing to pay.
2. Price discrimination attempts to turn consumer surplus into additional revenue for the seller.
3. There are 3 degrees of price discrimination

Question 4

First Degree price discrimination (or perfect price discrimination)

Answer 4

• First degree price discrimination is where each individual customer is charfed the maximum they would be willing to pay
• This would turn all the consumer surplus into extra revenue for the seller. In the diagram, total revenue = red and grey shaded areas combined.
• However, the cost of gathering the required information to do this, and the difficulty in preventing seepage, makes this method unlikely to be used in practice.

Question 5

Second Degree price discrimination

Answer 5

• Second Degree price discrimination is often used in wholesale markets, where lower prices are charged to people who purchase large quantities.
• This turns some of the consumer surplus into revenue for the seller, and encourages larger orders
• In the diagram, the seller charges P1 per unit for the customers buying Q1, and P2 per unit for the customers buying quantity Q2.
• If all customers were charged P1, then the firm’s total revenue would be all the grey area. By charging some customers P2, the red area is turned into additional revenue for the firm.

Question 6

Third Degree price discrimination

Answer 6

1, Third degree price discrimination is when a firm charges different prices for the same product to different segments of the market. These segments could be:
- customers of different ages - e.g. a leisure centre might have different prices for adults and children
- customers who buy at different times e.g. telephone company might charge diff amounts during office hours and in evening.
- Customers in different places e.g. a pharmeceutical company might sell goods at different prices in different countries
2. For example a seller can identify two groups of customers (Group A and B) with different price elasticities of demand (PED), as in these diagrams
LOOK AT DIAGRAM ON PAGE 67
3. To maximise profit, the seller would set the price for each group at the level where MR = MC. This means:
- it will charge a higher price to the group with more inelastic PED (e.g. Pa for Group A)
- it will charge a lower price to the group with more elastic PED (e.g. Pb for Group B)
- The red areas represent the supernormal profit earned from each group. This total supernormal profit is greater than if the same price was charged to everyone.

Question 7

Price discrimination is Good for Sellers and Possibly Bad for Others

Answer 7

Price discrimination certainly results in increased revenue for the seller. Whether this is fair or unfair depends on what happens to that extra revenue

1. The use of price discrimination means that some or all of the consumer surplus is converted into revenue for the seller - i.e. the seller increases revenue at the expense of the consumer. However, the extra revenue could be used to improve products, or invested into more efficient production methods => lower prices for consumers.
2. In all cases, the average revenue is greater than the MC - so price discrimination does not lead to allocative efficiency, because allocative efficiency is when P =AC.
3. Consumers are not treated equally but often the people who end up paying more have higher incomes, so are more able to afford those higher prices. Some people see this as fair, especially the greater profits made from some customers are used to subsidise lower prices paid by others (e.g. train passengers commuting to work pay high fares, and profits from these customers could be used to help support daytime services).