price discrimination

advantages of price discrimination - individuals

- Possibility of lower prices - Benefits to groups of consumers - Enables flexibility - Generating positive externalities - survival

Advantages of price discrimination - firm

- Profit maximisation - Economies of scale - Efficient use of infrastructure - Better use of space - Managing the flow customers - Understanding the market - Enables survival

Disadvantages of price discrimination

- limitation - Exploitation of captive markets

Necessary conditions for successful discrimination

1) The firm must be able to identify different market segments, such as domestic users and industrial users. 2) Different segments must have different price elasticises 3) Markets must be kept separate, either by time, physical distance and nature of use. Time based pricing - also called dynamic pricing - is increasingly common in goods and services sold online. In this case, prices can vary by the second, based on real-time demand related to consumers' online activity. 4) There must be no seepage between the two markets, which means that a consumer cannot purchase at the low price in the elastic sub-market, and then re-sell to other consumers in the inelastic sub-market, at a higher price. 5) The firm must have some degree of monopoly power.

Market separation and elasticity

Discrimination is only worth undertaking if the profit from separating the markets is greater than from keeping the markets combined, and this will depend upon the relative elasticities of demand in the sub-markets. Consumers in the relatively inelastic sub-market will be charged the higher price, and those in the relatively elastic sub-market will be charged the lower price.

Advantages of price discrimination - firm - Understanding the market

Firms may wish to trial new products in different locations, and may match their prices to the specific demand conditions found in those local markets. Also, firms can offer discounts in order to get consumer feedback on these trialled products, and on existing ones. Similarly, price discrimination may enable firms sell to export markets, basing their prices on what consumers are prepared to pay in each territory - which can vary considerably from country to country. From a macro-economic perspective, international trade is likely to be created by price discrimination.

advantages of price discrimination - individuals

From the consumer's point of view, some, especially those in the highly elastic sub-market, may gain consumer surplus as a result of lower prices. Lower prices could also result from the application of scale economies

advantages of price discrimination - individuals

Having different prices may enable consumers to match their purchasing and shopping to their own free time.

Diagram for price discrimination - explained

If we assume marginal cost (MC) is constant across all markets, whether or not the market is divided, it will equal average total cost (ATC). Profit maximisation will occur at the price and output where MC = MR. If the market can be separated, the price and output in the relatively inelastic sub-market will be P and Q and P1 and Q1 in the relatively elastic sub-market.When the markets are separated, profits will be the area MC, P,X,Y + MC1,P1,X1,Y1. If the market cannot be separated, and the two submarkets are combined, profits will be the area MC2,P2,X2,Y2. If the profit from separating the sub-markets is greater than for combining the sub-markets, then the rational profit maximizing monopolist will price discriminate.

Effects of Arbitrage

The effect of this is to make prices converge, given the different effects of buying and selling in the market.

Costs of separation

The effectiveness of price discrimination will be weakened if the costs of preventing seepage are significant, and reduce the profits accruing from discrimination.

Disadvantages of price discrimination - limitation

Ultimately, the ability to price discriminate may be limited because the conditions necessary are not fully met.

Arbitrage

a process where traders, acting as either buyers or sellers, can exploit price differences for identical products - buying where the price is lower and selling where it is higher.

advantages of price discrimination - individuals

able extend the analysis to consider the role of price discrimination in reducing market failure, such as enabling wider consumption of merit goods.

first degree price discrimination

alternatively known as perfect price discrimination, occurs when a firm charges a different price for every unit consumed. The firm is able to charge the maximum possible price for each unit which enables the firm to capture all available consumer surplus for itself. rare.

second degree price discrimination

charging a different price for different quantities, such as quantity discounts for bulk purchases.

third degree price discrimination

charging a different price to different consumer groups. most common type

Disadvantages of price discrimination - Exploitation of captive markets

consumers in a captive sub-market are being unduly exploited due to their in elasticity.

advantages of price discrimination - individuals

discounts encouraging demand and helping generate revenue

example of cost seperation

it might be necessary to introduce costly monitoring and enforcement systems to ensure that consumers do not break any conditions of sale which exist to keep markets separate. Employing ticket inspectors or other security systems adds to the cost of preventing seepage in public transport.

Advantages of price discrimination - firm - Profit maximisation

matching prices to the specific characteristics of the market, and its various segments, is a profit maximising strategy, where the firm can extract some of the consumer surplus available in the market, and turn it into producer surplus.

Example of first degree price discrimination

maximum possible price for each unit

example of second degree price discrimination

quantity discounts for bulk purchases.

example of third degree price discrimination

rail and tube travellers can be subdivided into commuter and casual travellers Splitting the market into peak and off peak use is very common

price discrimination

the business practice of selling the same good at different prices to different customers

advantages of price discrimination - individuals

Consumers can also gain from the fact that firms can more easily survive, so that future generations can derived continued benefit.

Advantages of price discrimination - firms - Efficient use of infrastructure

Price discrimination can benefit firms with high fixed costs associated with the building of infrastructure, and its maintenance. This includes natural monopolies such as gas, electricity supply, and transport services.

Advantages of price discrimination - firm - Better use of space

Similarly, price discrimination may also enable manufacturing and retail firms to clear their existing stocks quickly when required

Advantages of price discrimination - firm - Enables survival

As a result of generating additional revenue, price discrimination can enable firms to survive.

Advantages of price discrimination - firm - Managing the flow customers

Price discrimination according to the time of day means that the flow of customers into retail stores can be managed more effectively, which might provide a better experience for shoppers and spread out the work for staff.

Advantages of price discrimination - firm - Economies of scale

Given that charging different prices can increase sales volume, especially as a result of new consumers entering the market, attracted in by the discounted prices, firms can benefit from the economies of scale which arise from increased output and production.