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What is Price Discrimination?
Price discrimination is a distinct pricing strategy focusing on charging consumers different prices on the same product or service based on particular factors. Essentially, the pricing strategy is based on what a seller thinks customers will pay for the selected product or service. More notable, in pure price discrimination, a seller pursues the idea of charging the maximum possible price to get the most revenue from each consumer. Yet, in more general scenarios, the pricing strategy focuses on targeting various groups of prices based on particular criteria.
Often, there are two particular elements involved in price discrimination. The first one concerns various demographic factors urging sellers to perceive any particular group of buyers in a certain manner. The second one is about the final pricing decisions a seller sets you to get a maximum price based on demographics. In such a case, the pricing strategy is most valuable when the profit earned from different markets is higher than the profit earned to keep the needs together. One can say that the willingness of buyers to pay a particular price on a product or service depends on the market and sub-market elasticity.
When it comes to different conditions required for price discrimination and consumer surplus to emerge, one should speak of certain elements:
- Imperfect competition. To appeal to price discrimination a company needs to be a price marker, which means being able to operate in a market with imperfect competition. In other words, to employ price discrimination to reach consumer surplus, there should be a degree of monopoly involved.
- Resale prevention. To appeal to the pricing strategy, a company needs to be able to prevent resale. It means that consumers who have already bought products and services at a lower price should not have the ability to resell them for a higher price for other consumers.
- The elasticity of demand. For price discrimination to emerge, various groups of consumers must demonstrate the differentiating elastic of demand. Simply put, low-income consumers need to be more elastic in purchasing an airplane ticket, for instance, compared to business travelers. If there is an equal degree of elasticity of demand, price discrimination as a pricing strategy will not work properly.
To get a consumer surplus and execute price discrimination, one should have one or more of the conditions mentioned above. These are the conditions that make price discrimination happen.
Types of Price Discrimination?
When it comes to different types of price discrimination, it is crucial to mention three particular kinds.
- First-degree price discrimination. Also known as perfect or pure price discrimination, this type of pricing strategy is also known as perfect or pure price discrimination. It occurs when a company charges the maximum possible price it can get from a consumer. Because the price is different and varies across the product portfolio, the business captures all potential consumer surplus. Many sectors use client service practice where a business charges varying prices for every unit of product sold.
- Second-degree price discrimination. This type of price discrimination occurs when a company charges different prices for various quantities of products consumed. It applies to bulk purchases and quantity discounts. Second-degree price discrimination is important for companies that want to sell products in bulk.
- Third-degree price discrimination. This type of price discrimination happens when a business charges a different price to various groups of consumers. For instance, a movie theater can differentiate customers based on various age groups. Each group will pay a different price for seeing the same motion picture. This type of price discrimination is most commonly used.
These three types of price discrimination correlate to different approaches to customer surplus. Based on the characteristics at play along with sellers' willingness to charge particular prices based on the selected traits.
Advantages of Price Discrimination?
While price discrimination can sound like not a good pricing strategy, there are particular benefits it can bring in certain circumstances.
- Profit maximization. In proper conditions and when correctly used, price discrimination turns a consumer surplus into a seller surplus. Besides, in a first-degree price discrimination strategy, the entirety of all consumer surplus is turned into producer surplus. Smaller companies can use price discrimination to survive and get the most of their products to stay competitive.
- Economies of scale. Sales are likely to increase when businesses use different pricing points. In such a case, companies benefit from the boost in their production directed at the utilization of economies of scale. After making a profit, an increase in sales volumes is the next best thing.
- Lower prices. The two aspects mentioned above correlate to companies' benefits of price discrimination. Yet, there is a particular advantage of the approach to customers as well. Namely, price discrimination potentially brings lower prices for certain groups of consumers. Customers with high elasticity can gain consumer surplus.
Considering these advantages, price discrimination presents itself as a beneficial pricing strategy when properly applied. However, to get the most out of the approach, it is important to pursue the strategy in a particular manner and anticipate certain challenges that can emerge.
Disadvantages of Price Discrimination?
While there are certain benefits of price discrimination, there are drawbacks. When thinking about the approach, consider the following:
- Higher prices. As presented in the benefits, some consumers receive lower prices as a result of price discrimination. In such a case, there are other customers, the ones who will receive higher prices. The ones facing higher price are in a disadvantage. Returning to the example with an airline ticket, one can suggest such customers to be the ones who managed to buy a ticket in the peak season. Respectively, their consumer surplus will result in higher prices.
- Consumer surplus reduction. Price discrimination is the pricing strategy that can lead to the reduction of consumer surplus. It is the moment when the money are transferred from customer to producers, which lears to inequality. In such a situation, a lower consumer suplace leads companies and customer to a disadvantage.
Aforementioned principles correlate to the things in price discrimination that need to be considered. Respectively, price discrimination is not a panacea. It has particular advantages and disadvantages. One should always be cautions about price discrimination and keep all the aspects in mind.
Price discrimination is a pricing strategy that allows sellers to set particular prices best on demographic of consumers as well as the desires of the producers. The three distinct types of price discrimination directly depend on profit maximization aspects sellers set in front of them. There are particular benefits and drawbacks to price discrimination. Knowing that is important for making the most of the approach at hand.
Find answers to some of the most common questions people have regarding the use of Competera.
What is a market price discrimination pricing example?
Airline industry is one of the best examples when price discrimination can be adopted. The customers who purchase tickets in advance pay lower prices. In turn, people who buy tickets closer to the flight departure, pay more.
Is price discrimination illegal?
Price discrimination is not illegal per se. However, following the Sherma Antitrust Act, and Robinson-Patman Act, when the approach is taken to extreme, it is outlawed. Namely, when the intent to harm competitors, such type of price discrimination is illegal.