Price Discrimination

IB Economics
Conditions needed to Price
Discrimination:
discriminate Where a firm sells
An example would be an airline selling a identical products at
child’s ticket to fly from Vienna to Toronto different prices to
which may cost $500 while adult’s ticket costs different buyers for
$700 – the product is exactly the same but the reasons other than
price is different and it is not to do with the cost differing cost of
of supply supply
There are 3 conditions necessary for
discrimination
1. Producer must have price setting
ability
most often found in monopoly and
oligopoly markets
Not possible in perfect competition
2. Consumers must have different
elasticities of demand for the product
If the PED is more inelastic they will
be more willing to pay a higher price
Conditions needed to
discriminate
3.Producer must be able to separate
consumers so they cannot buy and sell on
Various ways they can separate
 Time – e.g. people travelling on trains at
different times – those needing to get to
work in the morning will have an inelastic
demand compared to those going out
shopping who can alter their time of travel
 Age – children are charged a lower price at
the cinema because their demand is more
elastic having lower income
 Gender – a football club in Sweden charges
lower prices for female supporters than for
male supporters (apparently they are not as
keen and therefore have a more elastic
demand)
Conditions needed to discriminate
 More ways they can separate
 Income – lawyers will often charge higher prices to
wealthy clients who have a relatively inelastic
demand for legal services
 Geographical distance – this is only possible if the
cost of transferring is greater than the difference in
the price
 CDs are sold for a lower price in the USA than
they are in the EU (there are different elasticities
in the 2 countries)
 Types of consumer – different users buy the service
at different prices – electricity companies often
charge different rates to industrial and domestic
users
 If the 3 conditions don’t exist the price discrimination will
not happen
 Be careful not to confuse promotion with price
discrimination
 Letting girls into a night club free is not price Not price
discrimination because the PED is not different – this discrimination
is just promotion (promotion)
Three degrees/Levels of
discrimination First Degree
 First degree price discrimination Discrimination –
 Each consumer pays exactly the price that selling each good
he /she is prepared to pay at highest
possible price to
 This is how traders in a market operate each individual
when they bargain to get the highest price buyer (perfect)
they can
 In this diagram a trader is selling world cup
t-shirts to tourists in a market
 The trader bargains with each tourist
 If the trader is successful he will sell one
shirt at $14, one at $13, one and $12 and
so on
 If the trader did not discriminate the total
revenue (p x q) would be the shaded pale
blue rectangle
 Because he does he eliminates the
consumer surplus and gets the dark blue
triangle as well
 Because the extra revenue received from
each shirt (MR) is equal to the price D=MR
Three degrees/Levels of Second Degree
Discrimination –
discrimination the firm charges
 Second degree price discrimination different prices
 A firm charge different prices to depending on
consumers depending on how much how much they
purchase
they purchase
 Electric and Gas companies do this
 They charge a high price for the first
number of units (the essential ones)
and a lower price for extra units
consumed
 Mobile phone companies do the same
 In this diagram the first 50 messages
are charged at a rate of 30 cents each
and any messages over this number
are charged at a reduced rate of 20
cents
Three degrees/Levels of discrimination Third Degree
Discrimination –
 Third degree price discrimination a separate price
 Consumers are identified in different market segments is charged in
 A separate price is charged in each market segment each market
segment
 There are different price elasticities in each segment
 This is the most common type of discrimination
 This diagram show a typical example
 Cinema management has identified 2 market segments
(adults and students)
Three degrees/Levels of
discrimination
 Students have a more elastic demand
because they have lower incomes
 Management will have to charge a lower
price for students than adults
 They can separate the segments because
students will have to show some proof of
status e.g. student card
 This diagram shows the situation for a
week
Three degrees/Levels of
discrimination
The demand curve D(S) is more elastic than
D(A)
The marginal revenue curves are twice as steep
We assume that they are maximising profits
We use the diagram on the left to show total
sales
This has the marginal cost curve for the whole
cinema
The MR is the total of both MR(S) and MR(A)
That is why it is kinked
Three degrees/Levels of
discrimination
The cinema will profit maximise where MC=MR
It will serve 700 customers per week and the
marginal cost will be $5
We can then transfer the marginal cost to each
market position to find out the profit maximising
position in each
Student segment = 375 students for a price of
$7.5
Adult segment = 325 adults at $10.25
Three degrees/Levels of
discrimination
In third degree discrimination a
market may be broken up into more
than two segments but the principle
will still be the same
It is just simpler to only draw 2
segments
Evaluation
Price discrimination can be a good and a bad thing
It depends upon the situation and who the stakeholder is
Advantages to the firm:
The firm can get a higher level of revenue from a given
amount of sales
The producer can produce more and get economies of
scale
 Both the firm and the consumer can benefit if lower
average costs are achieved and prices are lowered
accordingly
A firm can drive competitors out of the more elastic
segment
 Profits gained from the inelastic market segment can
be used to lower prices in the elastic segment
 If a firm has a strong brand in its home country it can
use those profits to be aggressive in new elastic
foreign markets (however, if can be proved to sell
below production costs this is illegal according to the
rules of the WTO
Evaluation
Advantages to the consumer:
The consumer may be able to purchase a good or
service that otherwise they could not afford
 Lawyers often charge high prices to wealthy
clients and lower prices to low income clients
Some people will be able to purchase the product at a
lower price than they would have had to pay if the
producer could not charge a higher price to others
 Many universities charge foreign students higher
tuition fees than for domestic students
Price discrimination usually increases total output so the
product is available to more consumers
Economies of scale may equal lower prices
The disadvantages to the consumer are:
Consumer surplus is lost
Some consumers will pay more than the price that
would have been charged in a single, non-discriminated
market