Price Differentiation
Where firms charge different prices for the same good to different consumers, for reasons not
associated with differences in cost.
Aim: to transfer consumer surplus over to producer surplus
Types:
1. First-Degree, sellers charge each customer the maximum he or she will pay. E.g. flea markets
bargaining, reverse auctioning, bandwidth tender
2. Second-Degree, sellers change the price according to how much the customer buys, market
according to quantity e.g. staggered pricing.
3. Third-degree, where consumers are grouped together and charged different prices, must ensure
that markets are kept separate and that there are different demand conditions.
Conditions:
1. Market imperfection – the firm must have an ability to set prices and put up barriers to entry
2. No seepage – the markets must be separate: people shouldn’t be able to move from the more
expensive market into the cheaper one or resell cheaper goods in the more expensive one
3. P-Ed must differ between markets. The firm will charge higher prices in the market with less
elastic demand.
Effects of P.D.
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Earn more revenue for given level of sales, increasing profits and even allowing for certain firms
that would otherwise be unable to make a profit to survive.
A firm may use P.D. to drive competitors out of a market. If it is a monopoly at home then it may
cross subsidize its sales overseas to undercut competition and gain market share. E.g. Japanese
motor bikes, Chinese goods (dumping)
P.D. may allow for better use of fixed facilities. Higher prices leave facilities less congested for
those willing to pay more, and lower prices may allow customers to afford something they
otherwise could not. E.g. off peak prices for sports facilities or even hotels, golf courses, sports
courts, parking facilities, “evening out” of demand to allow optimize use of spare capacity and
fixed factors
Cross-subsidy between customers e.g. plastic surgeons, POSBank