Price Discrimination The practice of charging unequal prices or fees to different buyers (or classes of buyers) is called price discrimination.

Price Discrimination

• The practice of charging unequal prices or fees to different buyers (or classes of buyers) is called price discrimination

Reasons

• Price discrimination is carried out primarily to increase the profits of the discriminating firms. It occurs where different consumers are charged different prices in different markets for the same product or service, or where the same consumer is charged different prices for the same product, where the different prices are not due to differences in supply costs.

Condition

• There must be some imperfection of the market.

• Price elasticity must differ for units of the product sold at different prices

• Firm must be able to segment the market and prevent resale of units across market segments

Examples Of Price Discrimination

• Physicians charge more for an office visit if the patient has health insurance.

• “Sizing up their income” pricing by plumbers, auto mechanics, . . .

A Mercedes driver can pay more, so why not charge them more?

Types Of Price Discrimination

• 1st degree price discrimination

• 2nd degree price discrimination

• 3rd degree price discrimination

First-degree price discrimination

• This is referred to as “perfect” PD. The seller charges every buyer their “reservation price”—that is, the maximum price they are willing to pay rather then go without the marginal unit of the good or service

Necessary Conditions:

1. Each unit is sold at the highest possible price

2. Firm extracts all of the consumers’ surplus

3. Firm maximizes total revenue and profit from any quantity sold

First-degree price discrimination

Second-Degree Price Discrimination

• A form of price discrimination in which a seller charges different prices for different quantities of a good. This also goes by the name block pricing.

• Second-degree price discrimination is possible because decidedly different quantities are purchased by different types of buyers with different demand elasticities.

Second-Degree Price DiscriminationConditions

1. Market Control:

2. Different Buyers:

3. Segmented Buyers:

Second-Degree Price Discrimination

Third-Degree Price Discrimination

• Charging different prices for the same product sold in different markets

• Firm maximizes profits by selling a quantity on each market such that the marginal revenue on each market is equal to the marginal cost of production

Third-Degree Price Discrimination

In the real world, third degree price discrimination is quite common. For a firm to practice price discrimination it requires:

• Ability to set prices. Some market power

• Ability to segment different classes of consumers (e.g. rail card to prove you are a senior citizen)

• Ability to prevent resale. E.g. stop adults using student tickets.

Examples Of Third Degree Price Discrimination

Students frequently get 10% discount in shopssuch as Cinemas.

Why are students given 10% discount?

Examples Of Third Degree Price Discrimination

With lower income, students tend to be moresensitive to price elastic. Therefore, by cuttingprices for students, a firm may be able toincrease sales and revenue.

Third-Degree Price Discrimination

Product Bundling

• Combining two (or more) products into one• E.g. computers are often bundled with a

monitor and/or printer• There is no price discrimination in Pure

Bundling• Mixed Bundling is a very effective form of

price discrimination• Surprisingly, like co-promotions this can be

done with unrelated products also.

Varieties Of Bundling

Pure bundling

joint bundling

leader bundling

the two products are offered together for one bundled price

a leader product is offered for discount if purchased with a non-leader product

occurs when a consumer can only purchase the entire bundle or nothing

Peak - Load Pricing• Common form of price discrimination - peak-load pricing• Peak-load pricing: when goods are charged at a higher price at

times of peak demand and less at off-peak times• Examples: – Holiday costs– Telephone charges– Rail– Air fares– Cinema tickets– Restaurants– Clubs– Electricity

Peak - Load Pricing

• Reasons why Price is discriminated

• Different Elasticities:• Peak - Relatively inelastic –

Prices are raised• Off-peak – Relatively elastic

– Prices are lowered

• Peak - Marginal costs are higher

• Off peak – Marginal costs are lower

• Diminishing returns for increase in output or having to use additional equipment of higher operating costs

Peak - Load Pricing

• In the case of electricity:

• At off-peak times, the power stations with the lowest operating costs will be used

• At periods of peak demand, the stations with the highest operating costs will be used

• Because of this marginal cost is higher at peak times than at off-peak