Price Discrimination
Definition
Price discrimination is the selling of the same good or service to different customers at different
prices, where such price differences are not caused by differences in costs. For example, a cinema
charging students cheaper prices than adults, etc.
Degrees of Price Discrimination
This is covered in the text-books, but has NEVER been asked. It could be, so for completeness sake
you might be worth having a look at it.
Conditions
To achieve price discrimination, the following conditions must apply:
1. Some degree of monopoly power
The producer must have some degree of monopoly power, otherwise the Super Normal
Profits earned in the markets with the higher prices would attract other firms and they would
disappear.
2. Consumers must have different elasticities of demand
The producer must be able to identify which consumers have elastic demand (lower prices),
and which have inelastic demand (higher prices). For example, the reason cinemas offer
student discounts is because this group’s lower incomes mean they have a higher elasticity
of demand for the product.
3. Distinct and separate markets
The markets must be separate, with no connection. Otherwise arbitrage could take place,
with consumers buying in the market with the lower price and re-selling the products in the
more expensive market.
4. Consumers may be unaware that they are being charged different prices
Consumers may pay a higher price than someone else, if they don’t know that a cheaper
price is available.
5. Consumers may know that they are being charged different prices, but be indifferent
to it.
There may be circumstances where the consumer is indifferent to the fact they are paying
higher prices. The difference may be so small that they accept the higher price.
Diagrams
Yet another Note!!
The purpose of the diagram in this market is NOT to show AC, AR, SNP, etc.
It’s just showing how the firm uses a combined MR curve, made up of the two MR curves from the
two different markets.
So, don’t draw AC or try to work out profits – the graph is complicated enough as it is.
AR/MR Curves
 The first market is a monopoly market with downward sloping AR and MR curves (see graph 1)
 The second market is a perfectly competitive market, with a horizontal AR/MR curve (see graph 2)
The Combined MR Curve
To maximise revenue, the producer will take the highest MR available at each quantity. By overlaying the
two graphs onto a single graph (graph 3), this can easily be compared. The producer sells in Market 1
initially, because the MR is higher here, but eventually switches markets when the MR curve falls below that
in Market 2.
Equilibrium Output
This produces in effect a single MR curve.
Because we assume each firm tries to maximise profits, they will produce where MC = MR. This gives the
equilibrium quantity, QT.
This is the total quantity produced. This can be divided into the two markets in which it is sold. Q1 is sold in
Market 1 and the remainder in Market 2.
Conclusion
The firm is operating where MC = MR1 = MR2