Price Discrimination

ECON 401 Section:
Price Discrimination
Sarah E. Taylor
University of Michigan, Department of Economics
March 16, 2011
The idea behind price discrimination, is that the Monopolist wishes to capture
more of the willingness to pay of different consumers to improve profits. There are
several methods by which a firm may discriminate between consumers:
1. Perfect Price Discrimination (First-Degree Price Discrimination)
• The monopolist knows the willingness to pay (i.e. how much each consumer
would pay for a unit of the good) of each consumer and charges them
accordingly to extract all of the surplus possible. Notice that this outcome
is efficient, but it is just the case that the monopolist extracts all of the
surplus and leaves nothing to the consumers. The monopolist will produce
until the marginal cost exceeds the willingness to pay.
• Example. First-Degree Price Discrimination is primarily a theoretical concept, although the example of Universities offering different tuitions to
different students qualifies as a closely related real-world example. A University asks students questions about their household income to estimate
their willingness to pay, and accordingly offers them different tuitions via
needs-based scholarships.
2. Quantity Discrimination (Second-Degree Price Discrimination)
• The monopolist charges different price for different quantities. Customers
with different willingness to pay choose different quantities; thereby, the
monopolist extracts some surplus from the consumers.
• Example. Suppose a consumer is willing to pay $20 for the first sweater she
buys and $10 for the next, since after buying the first sweater there is no
longer such a dire need to have one. Retail stores, like Gap, will often sell
sweaters at “buy one get the second half off” or “buy one for the price of
$20 and two for the price of $30”—both such techniques will capture more
profits than simply offering each sweater bought at a fixed price of $20,
under which scenario only one sweater would be bought by the consumer.
3. Multi-Market Price Discrimination (Third-Degree Price Discrimination)
• The monopolist distinguishes between different groups of consumers, where
the elasticity of demand differs between groups, and accordingly offers
them different prices. Notice that the impact on welfare in this case is
• Example. Movie theaters offer different ticket prices to students, adults,
and seniors since each group has a different demand for movie tickets. For
example, students and senior citizens may be willing to pay less for tickets
since their income is potentially less compared to adults.