11.5: Price Discrimination

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Elasticity Conditions for Price Discrimination

In a competitive market, price discrimination occurs when identical goods and services are sold at different prices by the same provider.

learning objectives

Examine the use of price discrimination in competitive markets

Price Discrimination

In a competitive market, price discrimination occurs when identical goods and services are sold at different prices by the same provider. In pure price discrimination, the seller will charge the buyer the absolute maximum price that he is willing to pay. Companies use price discrimination in order to make the most revenue possible from every customer. This allows the producer to capture more of the total surplus by selling to consumers at prices closer to their maximum willingness to pay.

Price discrimination: A producer that can charge price Pa to its customers with inelastic demand and Pb to those with elastic demand can extract more total profit than if it had charged just one price.

An example of price discrimination would be the cost of movie tickets. Prices at one theater are different for children, adults, and seniors. The prices of each ticket can also vary based on the day and chosen show time. Ticket prices also vary depending on the portion of the country as well.

Industries use price discrimination as a way to increase revenue. It is possible for some industries to offer retailers different prices based solely on the volume of products purchased. Price discrimination can also be based on age, location, desire for the product, and customer wage.

Forms of Price Discrimination

There are a variety of ways in which industries legally use price discrimination. It is not important that pricing information be restricted, or that the price discriminated groups be unaware that others are being charged different prices:

Coupons: coupons are used in retail as a way to distinguish customers by their reserve price. The assumption is that individuals who collect coupons are more sensitive to a higher price than those who don’t. By offering coupons, a producer can charge a higher price to price-insensitive customers and provide a discount to price-sensitive individuals.
Premium pricing: premium products are priced at a level that is well beyond their marginal cost. For example, a regular cup of coffee might be priced at $1, while a premium coffee is $2.50.
Discounts based on occupation: many businesses offer reduced prices to active military members. This can increase sales to the target group and provide positive publicity for the business which leads to increased sales. Less publicized discounts are also offered to off duty service workers such as police.
Retail incentives: retail incentives are used to increase market share or revenues. They include rebates, bulk and quantity pricing, seasonal discounts
Gender based discounts: gender based discounts are offered in some countries including the United States. Examples include free drinks at bars for women on “Ladies Night,” men often receive lower prices at the dry cleaners and hair salons than women because women clothes and hair generally take more time to work with. In contrast, men usually have higher car insurance rates than women based on the likelihood of being in an accident based on their age.
Financial aid: financial aid is offered to college students based on either the student and/or the parents economic situation.
Haggling: haggling is a form of price negotiation that requires knowledge and confidence from the customer.

Industries that Use Price Discrimination

The airline industry uses price discrimination regularly when they sell travel tickets simultaneously to different market segments. Price discrimination is evident within individual airlines, but also in the industry as a whole. Tickets vary based on the location within the plane, the time and day of the flight, the time of year, and what city the aircraft is traveling to. Prices can vary greatly within an airline and also among airlines. Customers must search for the best priced ticket based on their needs. Airlines do offer other forms of price discrimination including discounts, vouchers, and member perks for individuals with membership cards.

The pharmaceutical industry experiences international price discrimination. Drug manufacturers charge more for drugs in wealthier countries than in poor ones. For example, the United States has the highest drug prices in the world. On average, Europeans pay 56% less than Americans do for the same prescription medications. However, in many countries with lower drug costs, the difference in price is absorbed into the taxes which results in lower average salaries when compared to those in the United States.

Academic textbooks are another industry known for price discrimination. Textbooks in the United States are more expensive than they are overseas. Because most of the textbooks are published in the United States, it is obvious that transportation costs do not raise the price of the books. In the United States price discrimination on textbooks is due to copyright protection laws. Also, in the United States textbooks are mandatory where as in other countries they are viewed as optional study aids.

Analysis of Price Discrimination

Price discrimination is present in commerce when sellers adjust the price on the same product in order to make the most revenue possible.

learning objectives

Analyze the use of price discrimination in commerce

Price Discrimination

Price discrimination exists within a market when the sales of identical goods or services are sold at different prices by the same provider. The goal of price discrimination is for the seller to make the most profit possible. Although the cost of producing the products is the same, the seller has the ability to increase the price based on location, consumer financial status, product demand, etc.

pricediscrimination.small_.png

Sales Revenue: These graphs shows the difference in sales revenue with and without price discrimination. The intent of price discrimination is for the seller to make the most profit possible.

Price Discrimination Criteria

Within commerce there are specific criteria that must be met in order for price discrimination to occur:

The firm must have market power.
The firm must be able to recognize differences in demand.
The firm must have the ability to prevent arbitration, or resale of the product.

Types of Price Discrimination

In commerce there are three types of price discrimination that exist. The exact price discrimination method that is used depends on the factors within the particular market.

First degree price discrimination: the monopoly seller of a good or service must know the absolute maximum price that every consumer is willing to pay and can charge each customer that exact amount. This allows the seller to obtain the highest revenue possible.
Second degree price discrimination: the price of a good or service varies according to the quantity demanded. Larger quantities are available at a lower price (higher discounts are given to consumers who buy a good in bulk quantities).
Third degree price discrimination: the price varies according to consumer attributes such as age, sex, location, and economic status.

Examples of Price Discrimination

Price discrimination is a driving force in commerce. It is evident throughout markets and generates the highest revenue possible by shifting the price of a product based on the consumer’s willingness to pay, quantity demanded, and consumer attributes. Many examples of price discrimination are present throughout commerce including:

Travel industry: airlines and other travel companies use price discrimination regularly in order to generate commerce. Prices vary according to seat selection, time of day, day of the week, time of year, and how close a purchase is made to the date of travel.
Coupons: coupons are used in commerce to distinguish consumers by their reserve price. A manufacturer can charge a higher price for a product which most consumers will pay. Coupons attract sensitive consumers to the same product by offering a discount. By using price discrimination, the seller makes more revenue, even off of the price sensitive consumers.
Premium pricing: uses price discrimination to price products higher than the marginal cost of production. Regular coffee is priced at $1 while premium coffee is $2.50. The marginal cost of production is only $0.90 and $1.25. The difference in price results in increased revenue because consumers are willing to pay more for the specific product.
Gender based prices: uses price discrimination based on gender. For example, bars that have Ladies Nights are price discriminating based on gender.
Retail incentives: uses price discrimination to offer special discounts to consumers in order to increase revenue. Incentives include rebates, bulk pricing, seasonal discounts, and frequent buyer discounts.

Examples of Price Discrimination

The purpose of price discrimination is to capture the market’s consumer surplus and generate the most revenue possible for a good.

learning objectives

Give examples of price discrimination in common industries

Price Discrimination

Price discrimination occurs when identical goods or services are sold at different prices from the same provider. There are three types of price discrimination:

First degree – the seller must know the absolute maximum price that every consumer is willing to pay.
Second degree – the price of the good or service varies according to quantity demanded.
Third degree – the price of the good or service varies by attributes such as location, age, sex, and economic status.

The purpose of price discrimination is to capture the market’s consumer surplus. Price discrimination allows the seller to generate the most revenue possible for a good or service.

Price discrimination: These graphs show multiple market price discrimination. Instead of supplying one price and taking the profit (labelled “(old profit)”), the total market is broken down into two sub-markets, and these are priced separately to maximize profit. The graph shows how a seller wants to generate the most revenue possible for a good or service. The elasticity of a market influences the profit.

Examples of Price Discrimination

There are industries that conduct a substantial portion of their business using price discrimination:

Travel industry: airlines and other travel companies use differentiated pricing often. Travel products and services are marketed to specific social segments. Airlines usually assign specific capacity to various booking classes. Also, prices fluctuate based on time of travel (time of day, day of the week, time of year). Prices fluctuate between companies as well as within each company.
Pharmaceutical industry: price discrimination is common in the pharmaceutical industry. Drug-makers charge more for drugs in wealthier countries. For example, drug prices in the United States are some of the highest in the world. Europeans, on average, pay only 56% of what Americans pay for the same prescription drugs.
Textbooks (physical ones, not your Boundless one!): price discrimination is also prevalent within the publishing industry. Textbooks are much higher in the United States despite the fact that they are produced in the country. Copyright protection laws increase the price of textbooks. Also, textbooks are mandatory in the United States while schools in other countries see them as study aids.

Price discrimination is prevalent in varying degrees throughout most markets. Methods of price discrimination include:

Coupons: coupons are used to distinguish consumers by their reserve price. Companies increase the price of a good and individuals who are not price sensitive will pay the higher price. Coupons allow price sensitive consumers to receive a discount. At the same time the seller is still making increased revenue.
Age discounts: age discounts are a form of price discrimination where the price of a good or admission to an event is based on age. Age discounts are usually broken down by child, student, adult, and senior. In some cases, children under a certain age are given free admission or eat for free. Examples of places where age discounts are given include restaurants, movies, and other forms of entertainment.
Occupational discounts: price discrimination is present when individuals receive certain discounts based on their occupation. An example is when active military members receive discounts.
Retail incentives: this includes rebates, discount coupons, bulk and quantity pricing, seasonal discounts, and frequent buyer discounts.
Gender based prices: in certain markets prices are set based on gender. For example, a Ladies Night at a bar is a form of price discrimination.

Key Points

In pure price discrimination, the seller will charge the buyer the absolute maximum price that he is willing to pay. Companies use price discrimination in order to make the most revenue possible from every customer.
Price discrimination is used throughout industries and includes coupons, premium pricing, discounts based on occupation, retail incentives, gender based discounts, financial aid, and haggling.
Industries known for using price discrimination to maximize revenue include airlines, pharmaceutical manufacturers, and textbook publishers.
Three factors that must be met for price discrimination to occur: the firm must have market power, the firm must be able to recognize differences in demand, and the firm must have the ability to prevent arbitration, or resale of the product.
First degree price discrimination – the monopoly seller of a good or service must know the absolute maximum price that every consumer is willing to pay.
Second degree price discrimination – the price of a good or service varies according to the quantity demanded.
Third degree price discrimination – the price varies according to consumer attributes such as age, sex, location, and economic status.
Price discrimination is present throughout commerce. Examples include airline and travel costs, coupons, premium pricing, gender based pricing, and retail incentives.
Price discrimination occurs when identical goods or services are sold at different prices from the same provider.
Industries that commonly use price discrimination include the travel industry, pharmaceutical industry, and textbook publishers.
Examples of forms of price discrimination include coupons, age discounts, occupational discounts, retail incentives, gender based pricing, financial aid, and haggling.

Key Terms

incentive: Something that motivates, rouses, or encourages.
price discrimination: The practice of selling identical goods or services at different prices from the same provider.
revenue: The total income received from a given source.
surplus: That which remains when use or need is satisfied, or when a limit is reached; excess; overplus.

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