Definitions

1. Price discrimination occurs when a producer charges a different price to different customers for an identical good or service, according the willingness/ability of different customers to pay for it.

Conditions for price discrimination

• Producer must have-some price-setting ability → Price discrimination isn’t suitable in perfect competition
• Consumers must have different PED for the product → If not, they wouldn’t be prepared to pay different prices for the product.
• Producer must be able to separate the consumers → If not, it destroys the ability for the producer to practice price discrimination.

Degrees of price discrimination

1. First degree price discrimination

• Takes place when each consumer pays exactly the price they were prepared to pay.
• Examples include bargaining for a product to get the price consumers want to pay.
• However, by discriminating → Eliminates consumer surplus of the tourists and the trader’s revenue increases, therefore demand = marginal revenue.

2. Second degree price discrimination

• Takes place when firms charge different prices to customers depending on how much they purchase.
• They charge a high price for the first few units, then lower prices for extra units consumed by the customers.
• Mostly used by utilities companies.

3. Third degree price discrimination

• Takes place when consumers in a market are segmented.
• Different prices offered for consumers depending on their PED.
• Therefore, the slope of demand curve for the product, such as movie tickets, changes as it would be more inelastic to teenagers and elastic for mature adults.

  

Advantages of price discrimination

• Enables producers to gain a higher level of revenue as consumer surplus is eroded.
• May enable firms to produce more of the product → Gain economies of scale → Lowers average costs and prices in all of the market segments.
  • Same effect also goes for consumers as well.
• Enable firms to drive competitors out of the more elastic market.
• Allow consumers to purchase a product they wouldn’t have been able to if other consumers weren’t paying a higher price.
• Allows consumers to purchase a product at a lower price than they would’ve had to pay if the producer hadn’t been able to secure higher prices from others.
• Readily available to more consumers → Increases total output.

Disadvantages of price discrimination

• Any consumer surplus before price discrimination will be lost.
• Some consumers have to pay more than they would’ve in a single, non-discriminated market.
• Some firms, like airline firms, might lose revenue since consumers don’t have to pay tickets if they are 2 years or older, which reduces the chances of profit maximization.