PRICE DISCRIMINATION
A monopolist may be able to engage in a policy of price discrimination. This
occurs when a firm charges a different price to different groups of
consumers for an identical good or service, for reasons not associated with
the costs of production. It is important to stress that charging different
prices for similar goods is not price discrimination. For example, price
discrimination does not does not occur when a rail company charges a
higher price for a first class seat. This is because the price premium over a
second-class seat can be explained by differences in the cost of providing
the service.
Conditions required for price discrimination to work
There are basically three main conditions required for price discrimination
to take place.
Monopoly power
Firms must have some price setting power - so we don't see price
discrimination in perfectly competitive markets.
Elasticity of demand
There must be a different price elasticity of demand for the product from
each group of consumers. This allows the firm to extract consumer surplus
by varying the price leading to additional revenue and profit.
Separation of the market
The firm must be able to split the market into different sub-groups of
consumers and then prevent the good or service being resold between
consumers. (For example a rail operator must make it impossible for
someone paying a "cheap fare" to resell to someone expected to pay a
higher fare. This is easier in the provision of services rather than goods.
The costs of separating the market and selling to different sub-groups (or
market segments) must not be prohibitive.
Examples of price discrimination
There are numerous good examples of discriminatory pricing policies. We
must be careful to distinguish between discrimination (based on consumer's
willingness to pay) and product differentiation - where price differences
might also reflect a different quality or standard of service.
Some examples worth considering include:
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Cinemas and theatres cutting prices to attract younger and older
audiences
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Student discounts for rail travel, restaurant meals and holidays
Car rental firms cutting prices at weekends
Hotels offering cheap weekend breaks and winter discounts
The aims of price discrimination
It must be remembered that the main aim of price discrimination is to
increase the total revenue and/or profits of the supplier! It helps them to
off-load excess capacity and can also be used as a technique to take market
share away from rival firms.
Some consumers do benefit from this type of pricing - they are "priced into
the market" when with one price they might not have been able to afford a
product. For most consumers however the price they pay reflects pretty
closely what they are willing to pay. In this respect, price discrimination
seeks to extract consumer surplus and turn it into producer surplus (or
monopoly profit).
Perfect Price Discrimination
Here the firm charges each individual the maximum price they are willing to
pay. Ie there is no consumer surplus. This is basically impossible unless the
firm knows exactly each consumers surplus!
second degree price discrimination
This type of price discrimination involves businesses selling off packages of
excess capacity at lower prices than the previously published/advertised
price.
Examples of this can be found in the hotel and airline industries where spare
rooms and seats are sold on a last minute standby basis.
In these types of industry the fixed costs of production (the costs that do
not vary with output) are high. For example, the high costs of building a
hotel or leasing a plane are clearly fixed. At the same time the marginal or
variable costs in these industries are small and predictable. Marginal costs
are the costs of providing an extra unit of output. If there are unsold airline
tickets or hotel rooms, it is often in the businesses best interest to offload
spare capacity at lower (discounted) prices, always providing that the
cheaper price that adds to revenue covers the marginal cost of each unit
The low cost airlines are an example of this: Customers booking early with
carriers such as AirAsia will normally find much lower prices if they are
prepared to commit themselves to a flight by booking early. Closer to the
date and time of the scheduled service, the price often rises, on the
justification that consumer’s demand for a particular flight becomes more
inelastic the nearer to the time of the service.
third degree (multi-market) price discrimination
Introduction
This is the most frequently found form of price discrimination and involves
charging different prices for the same product in different segments of the
market. The market is usually separated in two ways: by time or by
geography. For example, exporters may charge a higher price in overseas
markets if demand is more inelastic than it is in home markets.
How it works
Suppose that a firm has separated a market by time into a peak market with
inelastic demand, and an off-peak market with elastic demand. The firm
aims to charge a profit maximising price to each group. Consumers with an
inelastic demand for the product will pay a higher price than those with an
elastic demand .
Effects of Price Discrimination:
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Reduces consumer surplus although some consumers may be charged
a lower price than before.
Increases firms revenue
The extra revenue may allow a previously loss making venture, to
make a profit and therefore everyone benefits as now a service is
provided that otherwise would not have been. Eg a doctor in rural
Thailand cannot make a profit by charging everyone the same price.
Most people cannot afford the costs. Therefore the community has
no doctor. So they discriminate charging the rich far more and the
poor far less. Everyone now has a doctor and all benefit.