PRICE DISCRIMINATION —MEANING, CONDITIONS AND TYPES

Price discrimination occurs when a firm charges different prices to different buyers of identical goods due to reasons not related to differences in cost

Any business can use price discrimination to boost profit. Price discrimination typically results in less consumer surplus and more producer surplus. Price discrimination is frequently linked to monopolies.

Conditions Necessary For Price Discrimination

Three requirements must be met for a company to price discriminate, which are: the company must have market power, the company must be able to segment its market, and the company should be able to deter the resale of its goods.

1. The firm must have market power: This means firms seeking to price discriminate should have the market power to raise prices above marginal cost.

If a firm lacks market power, then it cannot price discriminate.

This is the reason perfectly competitive firms can not price discriminate because they are mostly price takers.

READ ALSO: CAN A PERFECTLY COMPETITIVE FIRM PRICE DISCRIMINATE?

2. The firm must be able to segment its market demand: The firm should have the capacity to divide its market demand into different segments depending on its price elasticity of demand.

The firm may divide its market demand into an elastic segment (buyers who are price-sensitive) and an inelastic segment (buyers relatively insensitive to price).

They might charge less to elastic customers and more to inelastic customers.

3. The firm should be able to prevent arbitration or resale of the product: Even after segmenting its market, the business should be able to stop product resale to practice price discriminate.

There won't be any price discrimination if those from the lower-priced market can effectively acquire and resell goods to those from the higher-priced market.

Hence, a firm should be able to prevent resale to price discriminate.

Types Of Price Discrimination

There are three types of price discrimination, namely; first-degree price discrimination, second-degree price discrimination, and third-degree price discrimination. 

1. First-degree price discrimination: First-degree price discrimination, also referred to as perfect price discrimination, occurs when a business sells each unit of a good to different customers, charging each the amount (preferably the most) that they are willing to pay

To practice this kind of price discrimination, the seller of the good or service must have perfect knowledge of the maximum price that each consumer is willing to pay. 

He will then charge each customer the exact amount, leaving the consumer with no surplus. 

You will agree with me that it is almost impossible to correctly identify the maximum amount a consumer is willing to pay. 

Hence, this type of price discrimination is very rare. Perfect price discrimination allows the seller to obtain the highest revenue possible.  

To illustrate, a private doctor may charge his patient what he feels he can afford, just as a car dealer will likely consider how much a buyer might be willing to spend for a car.

The car dealer might charge wealthy buyers higher-than-normal prices and charge poor buyers normal car price

In each case, it is practically impossible to resale. Please take note that when a company uses first-degree price discrimination, the marginal revenue curve and the demand curve will be the same.

This indicates that the price and marginal revenue are equal.

2. Second-degree price discrimination: Here, a higher price is charged for the first unit followed by a lower price as subsequent units are purchased. 

A different name for second-degree price discrimination is quantity price discrimination.

In second-degree price discrimination, the price of goods and services varies according to the quantity demanded.

Larger quantities are obtainable at lower prices. The reason is that discounts are given to consumers who buy in bulk quantities. 

A good example is where progressive discounts are given as purchases increase. This is common with season tickets to watch a Premier League football team in the UK. 

Consumers generally gain from quantity price discrimination, and the firm's output, total revenue, and profits all rise.

3. Third-degree price discrimination: The most prevalent type of price discrimination is third-degree discrimination. It is also called multi-market price discrimination

Here, a company discriminates between categories of consumers based on differences in price elasticity of demand for its products. 

Customers whose demand is highly elastic are charged less.

Customers with inelastic demand, on the other hand, may be charged higher prices because they are less price sensitive.

Customers' price sensitivity may be affected by factors including age, sex, geography, economic position, or even the urgency of the delivery.

In the aviation sector, for example, customers who book their flights earlier pay less price than those who booked their flights a few days before the departure date.

This is an example of Multi-Market price discrimination. 

The only problem with multi-market price discrimination is that some consumers benefit while others do not because they have to pay higher prices.

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CONCLUSION

We have come to the end of this blog post. We have covered the meaning and types of price discrimination. 

Recap: Price discrimination is the practice of charging different consumers different prices for reasons unrelated to the cost of manufacturing.

In the next post, you will find some exercises to test and solidify your knowledge of price discrimination. Be sure to check it out!

To put Your knowledge to the test, I recommend that you take this quiz.

Which of the following is needed to practice price discrimination?


Ability to prevent resale
Ability to separate the market
Some degree of monopoly power
All of the above

see explanation

To successfully price discriminate, three conditions are essential

1. possess some market power or monopoly power

2. Ability to separate market

3. Ability to prevent resale

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