Price

Discrimination
Managerial Economics
Price discrimination occurs when a
business charges a different price to
different groups of consumers for
the same good or service, for
reasons not associated with costs.
Two main conditions required for price
discrimination to work
Differences in price elasticity of demand:
Charge a higher price to group with low PED
Charge lower price to consumers with a more
price elastic demand

Prevent resale / consumer switching

Easier with services than goods
Time limits product bought at certain time
Photo cards / identification systems
Electronic / digital ways of protecting usage
 Types of Price Discrimination
1. First-degree price discrimination occurs when
each unit of output is sold at a different price
such that all consumer surpluses go to the seller.
2. Second-degree price discrimination occurs
when the seller prices the first block of output at
a higher price than subsequent blocks of output.
3. Third-degree price discrimination occurs when
different prices are charged to groups of buyers
in totally separate markets.
 1st Degree Discrimination
Sometimes known as optimal pricing

The firm separates the market into each individual

consumer and charges them the price they are
willing and able to pay.

If successful, the business can extract the entire

consumer surplus that lies underneath the demand
curve and turn it into extra revenue or producer
surplus
 1st Degree Discrimination
Price, Cost Normal profit
maximising price
where MR=MC
P1 output sold at a
uniform price P1

20 Marginal
Cost
AR

Q1 Output (Q)
MR
 1st Degree Discrimination
Price, Cost Extra revenue and
profit to be made
from pricing
P1 according to
willingness &
ability to pay

20 Marginal
Cost
AR

Q1 Output (Q)
MR
 1st Degree Discrimination
Price, Cost If the market can be split
up final output will be
higher at Q2
P1
Aim is to draw from each
consumer what they can
pay for the product

20 Marginal
Cost
AR

Q1 Q2 Output (Q)
MR
2nd Degree Price Discrimination
Selling blocks of tickets / products in
larger quantities

Getting rid of excess inventories /

stocks when demand is low

Standby tickets for hotels, theatres,

flights etc

Peak and off-peak pricing schemes

e.g. travel, telecommunications
 3rd Degree Discrimination
Most frequently found form of price discrimination
and involves charging different prices for the same
product in different segments of the market.

The key is that third degree discrimination is linked

directly to consumers willingness and ability to
pay for a good or service.

It means that the prices charged may bear little or

no relation to the cost of production
 3rd degree discrimination
Price Low Price High Ped consumer
Ped are price sensitive

AR
MC MC

MR
AR
MR

Output (Q) Output (Q)

 3rd degree discrimination
Price Price

P1

AR
MC MC

MR
AR
MR

Q1 Output (Q) Output (Q)

 3rd degree discrimination
Price Price

P1
High Ped low profit
maximising price

P2
AR
MC MC

MR
AR
MR

Q1 Output (Q) Q2 Output (Q)

 3rd degree discrimination
Price Price
Price P2 would
keep this group out
P1 of the market
P2

P2
AR
MC MC

MR
AR
MR

Q1 Output (Q) Q2 Output (Q)

Evaluation Question
Evaluate the view
that a strategy of
price discrimination
by a producer always
works more in the
interests of
producers rather
than consumers and
society as a whole
Merits of Price Discrimination
Potential for cross subsidy of activities
that bring wider social benefits

Making better use of spare capacity

helps to keep businesses in business

Bringing some new consumers into

market otherwise excluded by price

Use of monopoly profit for research

a stimulus to innovation in long-run
Demerits of Price Discrimination
Exploitation of the consumer majority still pay
more than marginal cost causing loss of allocative
efficiency

Extraction of consumer surplus turned into higher

producer surplus / supernormal monopoly profit

Possible use as a predatory pricing tactic / and

barrier to entry / might cause trade tensions

Reinforces the monopoly power / dominance of

existing firms which is not in long run interest of
consumers (higher prices eventually)