Price Discrimination

• Price discrimination occurs when different prices are charged to consumers for an identical good or service with no difference in costs
• For firms to price discriminate, they need to:

  • Have some element of market power
  • Have relevant information to differentiate
  • Limit reselling
• First degree price discrimination occurs when each consumer is charged the exact price that they are willing to pay for a good or service, this means all consumer surplus is now converted into profit however this is just a theoretical concept
• Second degree price discrimination is also knows as excess capacity pricing where empty seats, space or excess stocks are sold at a lower price to contribute towards fixed costs
• Third degree price discrimination occurs when a firm is able to segment the market into at least two different groups; a group with price elastic demand and a group with price inelastic demand
• We assume that marginal cost is constant meaning MC = AC to simplify the price discrimination diagrams
• Cons of price discrimination:

  • Consumer surplus is reduced and allocatively inefficient
  • Firms using third degree price discrimination may use excessive profits to drive out competition (predatory pricing)
  • Third degree pricing also worsens income inequality
• Pros of price discrimination:

  • Can provide dynamic efficiency which is reinvested into technology
  • Third degree price discrimination benefits consumers in the price elastic section and so do last minute deal takers in second degree price discrimination
  • Price discriminating monopolists can cross subsidise loss making goods and services
  • Price discrimination can increase the total output being produced by the firm which may allow the firm to exploit economies of scale meaning lower average costs and lower prices