PRICE DISCRIMINATION Business charge different prices to different group of consumers for almost the same goods or service s.
DEFINITION: When firms have market power they can sometimes increase their profits through price discrimination. PD occurs when same product is sold to different consumers at different prices. For exam ple, Age based pricing such as charging less for a child's ticket to a movie theatre/amusement park than an adult. Price discrimination allows a company to earn higher profits than standard pricing because it allows firms to earn the highest possible revenue from the consumers. For example, movie theaters usually charge three different prices for a show. The prices target various age groups, including youth, adults and seniors. The prices fluctuate with the expected income of each age bracket, with the highest charge going to the adult population. It is important to stress that charging different prices for similar goods is not pure price discrimination. We must be careful to distinguish between price discrimination and product differentiation differentiation of the product gives the supplier gre ater control over price and the potential to charge consumers a premium price because of actual or perceived differences in the quality / performance of a good or service.
CONDITIONS APPLICABLE FOR PRICE DISCRIMINATION: There are three conditions which a firm may consider before setting up or practicing price discrimination. y
The firm needs to have some control over price, so that they are able to have success over having PD. A price taker in a perfectly competitive market would certainly not benefit or benefit extremely less with PD.
y
Grouping
different markets in terms of price e lasticity of demand in each, when the demand is
less elastic then the total profit increases with higher price. y
The products should not be resalable.
TYPES OF PRICE DISCRIMINATION: First-degree discrimination : It is charging whatever price the market will bear. Sometimes known as optimal pricing, with perfect price discrimination, the firm separates the whole market into each individual consumer and charges them the price they are willing and able to pay. If successful, the firm can extract all consumer surpluses that lie beneath the demand curve and turn it into extra producer revenue (or producer surplus). This is impossible to achieve unless the firm knows every consumers preferences and, as a result, is unlikely to occur in the real world. The transactions costs involved in finding out through market research what each buyer i s prepared to pay is the main block or barri er to a businesses engaging in this form of price discrimination. As long as the price elasticity is less than one, it is beneficial to charge any amount of price to consumers; this is because, no matter how much the fluctuation in prices, the demand change tends to be of smaller proportion as to price. The reality is that, although optimal pricing can and does take place in the real world, most suppliers and consumers prefer to work with price lists and price menus from which trade can take place rather than having to negotiate a price for each unit of a product bought and sold. price/cost per unit P1
A
P2 B
P3
MC=AC
Quantity per period Q1
Q2
Q3
Qd
Second-degree discrimination:
It is an imperfect form of first degree discrimination. Instead of setting different prices for each unit it involves pricing based on the quantities of output purchased by individual consumers. In second degree price discrimination, price varies according to quantity sold. Larger quantities are available at a lower unit price. This is particularly widespread in sales to industrial customers, where bulk buyers enjoy higher discounts. Moreover, sellers are not able to differe ntiate between different types of consumers. Thus, the suppliers will provide incentives for the consumers to differentiate themselves according to prefere nce. As above, quantity "discounts", or non-linear pricing, is a means by which suppliers use consumer preference to distinguish classes of consumers. This allows the supplier to set different price s to the different groups and capture a larger portion of the total market. In reality, different pricing may apply to differences in product quality as well as quantity. For example, airlines often offer multiple classes of seats on flights, such as first class and economy class. This is a way to differentiate consumers based on preference, and t herefore allows the airline to capture more consumers surplus. Price per unit
P1
P2
P3
Q1
Q2
Quantity per period
Third-degree discrimination:
The most common type of price discrimination is third-degree discrimination. It involves separating consumers or markets in terms of their price elasticity of demand. In third degree price discrimination, price varies by willingness or ability to pay such as location or by customer segment, or in the most extreme case, by the individual customer's identity. Additionally to third degree price discrimination, the suppliers of a market where this type of discrimination is exhibited are capable of differentiating between consumer classes. Examples of this differentiation are student or senior discounts. For example, a student or a senior consumer will have a different willingness to pay than an average consumer, where the reservation price is presumably lower because of budget constraints. Thus, the supplier sets a lower price for that consumer because the student or senior has a more elastic price elasticity of demand (see the discussion of price elasticity of demand as it applies to revenues from the first degree price discrimination, above). The supplier is once again capable of capturing more market surplus than would be possible w ithout price discrimination. Note that it is not always advantageous to the company to price discriminate even if it is possible, especially for second and third degree discrimination. In some circumstances, the demands of different classes of consumers will encourage suppliers to ignore one or m ore classes and target entirely to the rest. Whether it is profitable to price discriminate is determined by the specifics of a particular market.
Price, cost per unit
price, cost per unit
price, cost per unit
P2
P(t)
P1
D2 MC
MC
D(t) MC
D1
MR2
MR1 Q1
MR (t) Qty
Q2
Qty
Q (t)
QTY
EXAMPLES OF PRICE DISCRIMINATION: y
PIA use differentiated pricing regularly, as they sell travel products and services simultaneously to different market segments. This is often done by assigning capacity to various booking classes, which sell for different prices and which may be linked to fare restrictions.
y
Many movie theaters, amusement parks, tourist attractions, and other places have different admission prices per market segment: typical groupings are Youth, Student, Adult, and Senior.
y
A variety of incentive techniques may be used to increase market share or revenues at the retail level. These include discount coupons, rebates, bulk and quantity pricing, seasonal discounts, and frequent buyer discounts.
y
Wage discrimination is when the price of equivalent labor is discriminated among different groups of workers. This may be seen as just one kind of price discrimination or as an example of its inverse, one buyer buying identical goods at different rates.
