Price Discrimination

• Price discrimination


  A firm charges different prices to different consumers for an identical good or service with no differences in costs of production
• Conditions for price discrimination

  • Firm has price making ability (monopoly power)
  • Firm has information to separate market into different segments based on price elasticity of demand
  • Firm can prevent resale (market seepage)
• Degrees of price discrimination

  • First degree
  • Second degree
  • Third degree
• First degree price discrimination


  Consumers are charged the exact price they are willing and able to pay, eroding all consumer surplus and turning it into monopoly profit
• First degree price discrimination

  Turns consumer surplus into monopoly profit
• Second degree price discrimination (excess capacity pricing)

  Firm with fixed capacity lowers prices to fill excess capacity and contribute towards fixed costs<|>Consumers who pay lower price for excess capacity gain consumer surplus
• Firm has fixed capacity


  It makes sense to lower prices to fill excess capacity and contribute towards fixed costs
• Third degree price discrimination


  Firm segments market into different price elasticity of demand groups and charges different prices to each group
• Firm segments market into different price elasticity of demand groups

  Charges higher prices to inelastic demand group, lower prices to elastic demand group to maximize profits
• Pros of price discrimination

  • Greater profits for firm, potential for reinvestment and dynamic efficiency benefits
  • Some consumers benefit from lower prices (second and third degree)
  • Cross-subsidization of loss-making goods/services
• Cons of price discrimination

  • Allocative inefficiency from prices above marginal cost
  • Potential to increase income inequality
  • Anti-competitive effects from monopoly power
• The cons of price discrimination outweigh the pros, as the core issue of consumer exploitation is very significant