Chapter 11 - Price Discrimination

Price Discrimination Disadvantages to the Consumer

1. Any consumer surplus that existed before will be lost. 2. Some consumer will pay more than the price that would have been charged in a single, non-discriminated market.

Price Discrimination Advantages to the Firm

1. PD enables the producer to gain a higher level of revenue from a given amount of sales because consumer surplus is eroded. 2. PD may enable the producer to produce more of the product and thus gain economies of scale [could be beneficial to everyone, by lowering average costs and lowering prices in all of the market segments]. 3. PD may enable a firm to drive competitors out of the more elastic market. If the firm is able to price discriminate, then it may use profits gained in the inelastic market segment to lower prices in the more elastic segment and thus undercut its competitors in that segment.

Price Discrimination Advantages to the Consumer

1. PD may allow some consumers to purchase a product that they would not have been able to if other consumers were not paying a higher price and thus 'subsidizing' the poorer consumers [e.g. lawyers]. 2. PD allows some people to purchase a product at a lower price that they would have had to pay if the producer had not been able to secure higher prices from others. [e.g. foreign university students vs. domestic]. 3. PD usually increases total output in a market and so the product is available to more consumers in the market. 4. PD may lead to economies of scale which lower unit costs, and thus lower prices for consumers in all market segments.

Conditions for Price Discrimination

1. The producer must have some price-setting ability i.e. the market must be imperfect [is not possible in perfect competition]. 2. The consumers must have different price elasticities of demand for the product, so that the would be prepared to pay different prices for the product. 3. The producer must be able to separate the consumers, so that they are not able to buy the product and sell it to another consumer.

Ways of Producer Separation of the Market

1. Time: consumers are often prepared to pay higher prices at certain times than at others [e.g. commuters heading to work vs. casual shopper]. 2. Age: firms may charge different prices to consumers based upon their ages [e.g. children (more elastic demand) vs. adults]. 3. Income: firms may charge higher prices to people with high incomes [e.g. wealthier = relatively inelastic demand]. 4. Geographical Distance: firms often sell products in different regions at different prices [*as long as the cost of transferring the the product is greater than the difference in prices]. 5. Types of Consumer: firms sometimes sell at different prices to different consumers [e.g. domestics vs. industrial users or museum employees vs.visitors].

Second-Degree of Price Discrimination

Takes place when a firm charges different prices to consumers depending upon how much they purchase [often how utilities companies -gas and power - operate]. High price for first amount of units and then lower price for extra units.

Third-Degree of Price Discrimination

Takes place when consumers are identified in different market segments [can be more than two], and a separate price is charged in each market segment that recognizes the different price elasticities in each segment [overall this results in a kinked demand curve].

First-Degree of Price Discrimination

Takes place when each consumer pays exactly the price that he/she is prepared to pay. [e.g. consumers in a bazaar/market]. This eliminates consumer surplus and allows for greater total revenue. Also, since the marginal revenue is equal to the price of the shirt and so D=MR, and there is greater total revenue.

Cases of Sales Promotion and not Price Discrimination

e.g. Nightclubs letting girls in for free while boys have to pay is not price discrimination. It is unlikely that there is any difference in the price elasticity of demand between boys and girls.

Price Discrimination

exists when a producer sells the exact same product to different consumers as different prices.