What is the Price Discrimination? Definition, Example and more

Definition:

Price discrimination is a pricing strategy in which a business charges different prices for the same product or service to other groups of customers based on their willingness to pay. This practice can help businesses maximize their profits by charging higher prices to customers willing to pay more while still making sales to less inclined customers.

Price discrimination can be categorized in three degrees depending on the fact that how discrimination is carried.

First degree price discrimination

The first degree of price discrimination/perfect discrimination is when the business charges different prices for every unit consumed. The business would like to sell the units at the maximum price to get the highest profit from a sale. The business will get the entire market surplus it could be possible for it to achieve.

However, the first degree of price discrimination seems to be unrealistic as demand is elastic and the information is available to the consumer that a reduction in their interest to buy the product could lead to a decrease in the price. Hence, it’s rare to be able to exercise the first degree of price discrimination in the real world.

First degree price discrimination example

The first degree of price discrimination is when the business-used car dealer tries to negotiate a maximum price from the buyer of a car.

It’s up to the competence of the seller to charge the highest possible amount from the buyers. Hence, there is no fixed price and the price is different for each unit of the sales.

Second degree price discrimination

It happens when the business charges different prices based on the quantity of the purchase by the customer. If the quantity of purchase is higher the business charges a lower amount from the customer. On the contrary, if the quantity of the purchase is lower the business charges higher rates from the customer.

Quantity-wise discrimination of the price encourages the customers to buy more as they want to purchase the goods at a lower price, it’s the same as economies of scale.

Second degree price discrimination example

Consider a business where pulses are sold at USD 4 per kg. However, the price will be USD 3.5 per kg if the customer orders at least 10,000 kg of the pulses.

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Hence, there is an incentive for a customer to purchase the increased quantity of the goods and get discounts on their overall purchases.

Second-degree price discrimination intends to increase the sale of the quantity although the business has to discount for some amount.

Third degree price discrimination

The third degree of price discrimination is when the business charges different prices for the same goods/services to a different group of consumers. The group of consumers may be people affiliated with different subsets of society.

Third-degree price discrimination might be used by the business to ease some specific group of people as they might be naturally weak or the business perceives some specific group of consumers as their ethical responsibility to be discounted.

Third degree price discrimination example

Third-degree price discrimination is when the theatre charges differently from the students, professionals, and senior citizens.

The same goes with the air industry where the price of the ticket is less when booking is made in advance and the prices are higher if the ticket is booked at the last minute.

Third-degree price discrimination perfectly works to encourage early sales and build up brand loyalty among the people.

Price discrimination under monopoly

In a monopoly environment of the business, there is a single supplier that can control the pricing, production, and demand of the product in the economy.

The monopolist business can control the supply and demand of the specific market and charge the prices to the consumer on their terms. In other words, being a monopolist enables the business to be in a position to discriminate in price.

Conditions of price discrimination

Not each business can discriminate the prices of the products. To discriminate the prices the business must have sort of monopolistic power and control over the market.

If there is perfect competition in the market with information symmetry the business will not be able to charge discriminated prices from the customers.

Further, the market for the product needs to be divided into different segments. In other words, the business needs to identify separate groups of consumers to discriminate the price.

In addition to this, if the price discrimination is carried based on the geographical distribution the buyers from low price areas should not be able to access the buyers in the high price area else they might carry out the sales transaction and leave the business at loss technically.

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Finally, one of the geographical markets/segments identified should not be price sensitive or the elasticity of demand should be lower to enable the business to discriminate the price.

Basis of the price discrimination

The business can discriminate the price depending on different factors that include but are not limited to persons, geographical distribution, the basis of the users, etc. Let’s discuss these aspects in detail.

 Persons

The business may decide to charge different prices from different people. The difference in people may be due to their level of income, or any other reasons.

For instance, the physician may set higher prices for the rich people and lower prices for the poor people while maintaining the level of service for both the patients.

Geographical distribution

Alternatively, the business may opt to discriminate the price based on the location. There may be a different price for the same product in two different areas, regions, or countries.

The decision may be taken by the business as there may be competition in one area leading the business to charge low prices and the business may be monopolist on other geographic locations enabling it to charge higher prices.

Basis of the use

The basis of the use refers to how the buyer is using the product of the company. If the buyer consumes the product the business may consider charging the customer a lower price.

On the contrary, if the buyer makes commercial use of the product, the business may be able to charge higher prices.

For instance, an electricity supply company charges a higher rate for the residential consumer and higher for the commercial consumer.

What does price discrimination under monopoly depend upon?

Price discrimination under a monopoly depends on the monopolist’s ability to segment the market and identify different groups of customers with different price elasticities of demand.

The monopolist will typically charge higher prices to customers with a lower price elasticity of demand, as these customers are less likely to respond to price increases by reducing their need for the product. 

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Conversely, the monopolist may charge lower prices to customers with a higher price elasticity of demand. These customers are more likely to respond to price changes and may be lost to the monopolist if prices are too high.

To successfully engage in price discrimination, the monopolist must also be able to prevent arbitrage or the resale of goods from one market to another at a higher price. 

This can be achieved through various means, such as offering different product features or using customer identification methods.

Overall, price discrimination allows a monopolist to increase profits by charging different prices to different groups of customers based on their willingness to pay. 

However, it can also raise concerns about fairness and discrimination, particularly if certain groups of customers are systematically charged higher prices than others.

What is the most profitable level of output for a monopolist?

The most profitable output level for a monopolist is the level of output where marginal revenue (MR) equals marginal cost (MC). 

This is because a monopolist’s profit-maximizing strategy is to produce at a level where marginal revenue (the additional revenue generated by selling one more unit of output) equals marginal cost (the additional cost of producing one more unit of output).

At the point where MR = MC, the monopolist is producing the quantity of output where the additional revenue generated by producing one more unit (MR) is equal to the additional cost of producing that unit (MC). 

This is also known as the profit-maximizing output level, and it corresponds to the point on the monopolist’s demand curve where elasticity is equal to one.

Producing below this point would mean the monopolist is not fully exploiting its market power and could earn more profit by increasing output. 

Producing above this point would mean that the monopolist is incurring higher costs than the additional revenue generated, leading to a decrease in profit.

The monopolist’s profit-maximizing output level may not be socially optimal, as it may result in higher prices and lower output than would be produced under perfect competition. 

This is because the monopolist can restrict output and charge a higher price due to its market power, which can lead to a deadweight loss in the economy.