What is Price Discrimination?
Price discrimination involves charging a different price for the same good and service to different groups of people. There are three types of price discrimination – first-degree, second-degree, and third-degree price discrimination.
Benefits of Price Discrimination
1. It allows businesses to make money and those that are unprofitable avoid going bankrupt: this may enable a firm to turn a loss into a profit which allows them to keep on going rather than shutting down.
2. Some people benefit from lower prices: price discrimination means that firms will have an incentive to cut prices for different groups of consumers who are sensitive to prices. For example, students can benefit from a 10% discount on certain goods and services.
3. Avoids congestion: this is due to price discrimination being a way to manage demand. For example, if there were no price control on train services operating during rush hour then many trains would be overcrowded. Price discrimination gives people the incentive to go later in the day.
Different Types of Price Discrimination
First degree price discrimination (also known as perfect price discrimination) involves a firm charging different prices for every unit consumed. Firms will charge the maximum possible price for each unit being sold which enables the firm to capture all possible consumer surplus for itself.
The downward sloping demand curve captures all consumer surplus.
Second degree discrimination involves charging different prices for different quantities, such as receiving discounts on items bought in bulk. The price of goods and services varies depending on the quantity demanded — larger quantities tend to be sold at a lower price.
Third degree discrimination involves charging different prices to different groups of people. These groups can be identified by several characteristics such as their gender, location and age. Third degree price discrimination tends to be quite common in comparison to first and second degree discrimination. For a firm to set prices under this condition, they would need to have some market power, ability to prevent resale and the ability to segment different groups of consumers. For example, cinema tickets can be subdivided into adults and children and rail and tube tickets can be subdivided into peak for commuters and off-peak for casual travellers. Students often receive discounts on certain goods and services as a result of students being more sensitive to price changes. This is due to them having lower disposable income and a small change in price could result in goods being unaffordable. Adults tend to be less sensitive to price changes as they have higher income.
Student demand tends to be more price elastic, whereas adult demand is price inelastic. Therefore, by cutting prices for students, a firm can still gain profits by keeping the price for adults who have more inelastic demand relatively high.
As you can see below, there are two groups — adults and students. Adult demand is price inelastic, which means that they are faced with higher prices. Students, on the other hand, tend to be more elastic with demand, which results in lower prices.
Price Discrimination Revision Tips
1. Diagrams: with any Economics topic it is important for you to have a good understanding of the diagrams used, especially for price discrimination. This will allow you to gain a better understanding of the topic and allow you to score high marks in your examinations. I always made sure I had a notebook filled with diagrams so that when it came to revision, I was able to quickly pick up from it.
2. Familiarise yourself with topics that relates to price discrimination: this topic requires you to have a good understanding of other Economics topics, as they all tend to link together. For example, this topic will require you to have a good understanding of price elasticities (both demand and supply). Without a good understanding of this, it will be hard for you to grasp the concepts well, and it will also make it harder for you to understand the diagrams used.
3. Use examples: this is another important tip that I thought was useful for me as it enabled me to understand the subject in more detail. By relating each price discrimination to real life examples, it will enable you to remember each one quicker as they can be confusing at times. This will help you distinguish each price discrimination better so that when it comes to revision you will be able to pick this up quicker and will be able to gain a better understanding. This again is important for you to use during examinations, to show examiners that you know what you’re talking about.
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Linda helps to run our Admin Team. She graduated from the University of Leicester with a degree in Management and Economics. She enjoys taking time to learn and develop her skills, and is currently teaching herself French. Linda is passionate about travelling and has visited Dubai, New York, Texas, Orlando, Morocco and Paris. Her next stop is Amsterdam. Linda also enjoys cooking and is known to always look for new recipes to make or foods to try. She is well known for having the Food Network or Come Dine With Me running in her house — you can never have too many ideas.