Read about PRICE DISCRIMINATION
Watch another video on PRICE DISCRIMINATION
Could shopping online make you a victim of price discrimination...?
What are the main conditions necessary for price discrimination to work?
Here are the main conditions required for discriminatory pricing:
Differences in price elasticity of demand: There must be a different price elasticity of demand for each group of consumers. The firm is then able to charge a higher price to the group with a more price inelastic demand and a lower price to the group with a more elastic demand. By adopting such a strategy, the firm can increase total revenue and profits (i.e. achieve a higher level of producer surplus). To profit maximise, the firm will seek to set marginal revenue = to marginal cost in each separate (segmented) market.
Barriers to prevent consumers switching from one supplier to another: The firm must be able to prevent "consumer switching" – i.e. consumers who have purchased a product at a lower price are able to re-sell it to those consumers who would have otherwise paid the expensive price.
This can be done in a number of ways, – and is probably easier to achieve with the provision of a unique service such as a haircut, dental treatment or a consultation with a doctor rather than with the exchange of tangible goods such as a meal in a restaurant.
Here are the main conditions required for discriminatory pricing:
Differences in price elasticity of demand: There must be a different price elasticity of demand for each group of consumers. The firm is then able to charge a higher price to the group with a more price inelastic demand and a lower price to the group with a more elastic demand. By adopting such a strategy, the firm can increase total revenue and profits (i.e. achieve a higher level of producer surplus). To profit maximise, the firm will seek to set marginal revenue = to marginal cost in each separate (segmented) market.
Barriers to prevent consumers switching from one supplier to another: The firm must be able to prevent "consumer switching" – i.e. consumers who have purchased a product at a lower price are able to re-sell it to those consumers who would have otherwise paid the expensive price.
This can be done in a number of ways, – and is probably easier to achieve with the provision of a unique service such as a haircut, dental treatment or a consultation with a doctor rather than with the exchange of tangible goods such as a meal in a restaurant.
- Switching might be prevented by selling a product to consumers at unique moments in time – for example with the use of airline tickets for a specific flight that cannot be resold under any circumstances or cheaper rail tickets that are valid for a specific rail service.
- Software businesses often offer heavy price discounts for educational users providing they give an academic email address
- Students may be required to show proof of identification using secure ID cards
Summary of the main conditions
What is 1st degree (perfect) price discrimination?
Perfect Price Discrimination is charging whatever the market will bear
Perfect Price Discrimination is charging whatever the market will bear
- Sometimes known as optimal pricing, with perfect price discrimination, the firm separates the market into each individual consumer and charges them the price they are willing and able to pay
- If successful, the firm can extract the entire consumer surplus that lies underneath the demand curve and turn it into extra revenue or producer surplus.
- This is hard to achieve unless a business has full information on every consumer's individual preferences and willingness to pay. The transactions costs involved in finding out through market research what each buyer is prepared to pay is the main barrier to a business's engaging in this form of price discrimination.
- If the monopolist can perfectly segment the market, then the average revenue curve becomes the marginal revenue curve.
- A monopolist will continue to sell extra units as long as the extra revenue exceeds the marginal cost of production.
What is Second Degree Price Discrimination?
- This involves businesses selling off packages or blocks of a product deemed to be surplus capacity at lower prices than the previously published or advertised price.
- Price tends to fall as the quantity bought increases.
- Examples of this can be found in the hotel industry where spare rooms are sold on a last minute standby basis. In these types of industry, the fixed costs of production are high. At the same time the marginal or variable costs are low and predictable.
- If there are unsold rooms, it is in the hotel's best interest to offload spare capacity at a discount prices, providing that the extra evenue at least covers the marginal cost of each unit.
- There is nearly always some supplementary profit to be made. Firms may be quite happy to accept a smaller profit margin if it means that they manage to steal an advantage on their rival firms.
Peak and Off-Peak Pricing
Then there's THIRD DEGREE PRICE DISCRIMINATION.....- Peak and off-peak pricing and is common in the telecommunications industry, leisure retailing and in the travel sector.
- For example, telephone and electricity companies separate markets by time:
- There are three rates for telephone calls: a daytime peak rate, and an off peak evening rate and a cheaper weekend rate.
- Electricity suppliers also offer cheaper off-peak electricity during the night.
- At off-peak times, there is plenty of spare capacity and marginal costs of production are low (the supply curve is elastic)
- At peak times when demand is high, short run supply becomes relatively inelastic as the supplier reaches capacity constraints. A combination of higher demand and rising costs forces up the profit maximising price.
