Price discrimination refers to the practice of charging different prices for the same commodity to different consumers. Price discrimination can be practiced by the manufacturers, wholesalers or retailers and is highly dependant on the existence of a monopoly market. For price discrimination to be effective there should be some form of market power by the vendor exercising this practice otherwise, the practice can easily be interfered with when some customers become competitors and decide to sell the same product to other customers at a discounted price (Phillips 05). Therefore, anyone intending to practice price discrimination should either restrict information about his pricing system or make it hard for consumers to compare prices of the goods he is dealing in. In general, price discrimination practice will only work well in a segmented market. Having defined price discrimination, it is imperative to note that there are various types of price discrimination namely; First degree, second degree, third-degree price discrimination, price skimming and combination price discrimination. This paper will focus on discussing all these types of price discrimination and their importance to the Vendors.
First-degree price discrimination
In this type of price discrimination the seller divides the consumers into two; those that have high price elasticity and those with low price elasticity. Therefore, the price of the same good varies from one consumer to the other depending on the price elasticity of each consumer. The seller will always find it profitable to charge a high price to consumers whose price elasticity of demand is less than one and low prices to consumers whose price elasticity is greater than one. Therefore, it would require the seller to be keen enough to identify among the consumers of his product who are those that are willing to pay more and who are unwilling to pay more for the same product. This type of price discrimination is theoretical in nature as it requires the seller to identify the maximum price each consumer is willing to pay for the commodity and as a result, the entire surplus accruing in the market belongs to the seller (Salvatore 235).
Second-degree price discrimination
In this type of discrimination, the price of the product varies according to the quantity of the product being purchased. That is, the seller charges low prices to consumers who buy products in bulk and charges high prices to consumers buying goods in small quantities. The seller discriminates the prices by offering discounts to customers who purchase in bulk thus making them buy the same commodity cheaper than the consumers who buy fewer quantities. As a result, the seller can be able to capture most part of the market surplus if he is able to discriminate efficiently. This often occurs in retail shops where if one buys for example two shirts he/she pays less than the other customer who bought one shirt. Therefore, the seller is able to clear stocks in time and restock them (Varian 200).
Third-degree price discrimination
In this type of price discrimination, the prices vary depending on the location of the customers or simply market segmentation. The seller is presumed to be able to differentiate between his consumers’ classes and as a result, charges different prices depending on the class of the consumer. Those consumers with high social class will be charged high prices compared to those consumers considered to be of low social class. A good example of this kind of price discrimination is the student and senior price discrimination often exercised in a variety of shows such as drama, movies and concerts. It is easier to note that children, students and adults are charged different prices to enjoy the same service (Sloman 196).
In this type of price discrimination, prices vary over time from the time of its introduction into the market to the time the product establishes itself in the market. Therefore, when a product is just new in the market, its price is normally high but as the price elasticity of demands gets higher with time, the suppliers tend to reduce on price due to various factors such as entrance of substitutes goods or due to surplus production.
This is a type of price discrimination that combines other types of price discriminations such as the first degree, second degree and third-degree price discrimination (Greenhut, Norman and Hung 90).
Reasons for price discrimination
The main purpose for price discrimination especially to the suppliers or vendors is to maximize profit by making sure that they capture the consumers’ surplus in the market (Salvatore 240). Let’s take an example of two firms, one practicing price discrimination while the other does not. This is illustrated in the following diagrams
The first diagram indicates a supplier who does not exercise price discrimination while the second diagram represents the supplier or vendor who practices price discrimination. In the first case, a fixed price P is available to all consumers and thus the supplier earns revenue equivalent to area PAQO and the consumer’s surplus is equal to the area above PA. In the second diagram, the supplier earns revenues from two market segments with one market segment being consumers with low price elasticity while the next one having high price elasticity. The total revenue of the vendor or supplier is equal to the profits of both markets combined which is P1 B Q1 O and E C Q2 Q1. If the two market segment profits are added together, the supplier who practices discrimination turns out to be earning more revenue than the one who doesn’t. This is basically because the vendor has converted a large portion of the consumers’ surplus and made it a producer’s surplus.
Theoretically, price discrimination seems to be bad however, economically, it is the best practice by business community to maximize their profit especially by discriminating price according to class difference. The high price charge on high-income earners somehow compensates for the low prices paid by the low-income earners on the same good and still the producer remains with surplus. However, if price discrimination is misused, it may lead to the exploitation of consumers.
Greenhut, Melvin L., Norman, George, Hung, Chao-shun. The economics of imperfect competition: a spatial approach. Cambridge University Press, 1987.
Mas-Colell, A., Whinston, M., and Green, J. Microeconomic Theory, Oxford University Press,1995.
Phillips, Louis. The economics of price discrimination. Cambridge University Press, 1983.
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Salvatore, Dominick 4th Ed. Schaum’s Outline of Microeconomics. McGraw-Hill Professional, 2006 pp 235-240.
Sloman, John. Economics. Financial Times Prentice Hall, 2006 pp 197-180.
Varian, Hal. Intermediate Microeconomics, 7th ed. W.W. Norton, 2005.