Price Discrimination Flashcards
(8 cards)
What is Price Discrimination?
Price discrimination is charging different prices to different groups of consumers for an identical good or service for reasons other than differences in cost.
Price discrimination is possible when:
• there are high barriers to entry & firms have some monopoly power
• the supplier has some pricing power
• the market can be split into two or more distinct groups of consumers,
which have different PEDs
• there is no market seepage (consumers cannot buy in one sub-market and sell in another); the cost of keeping the markets separate should be low
It has potentially important welfare and distribution effects
What are the main aims of Price Discrimination?
• To increase revenue - extracting consumer surplus and turning it into
increased producer surplus for the seller
• To increase profits - total profit will rise providing the marginal profit from selling to extra customers is positive
• To use spare capacity - price discrimination can help a business make more efficient use of their supply capacity
What is First Degree Price Discrimination?
Firms charging each individual consumer, the maximum price that they are willing to pay; seller extracts all the consumer surplus
Without price discrimination:
Firm maximises profit by producing where MC=MR; profits = shaded area
What is Second Degree Price Discrimination?
Firms charging different prices depending upon quantity bought, time period, use of coupons
Costs of Price Discrimination?
• Consumers in the ‘inelastic demand’ sub-market pay a higher price
• There is a loss of consumer welfare (the firm extracts some of the consumer surplus); i.e. consumer exploitation
• Price discrimination may also firms to use predatory pricing tactics
• Can reinforce monopoly power
• Firms may not use the extra supernormal profit to improve the businesses; e.g. profits may be distributed to shareholders only
Benefits of Price Discrimination?
• Firm makes greater supernormal profits
• Firm extracts some of the consumer surplus to add to its profits
• Profits could be used to re-invest in the firm and increase dynamic
efficiency; firm may use profit for R&D and innovation
• Firm may use profit to improve the quality of its good/service
• Firm may use extra profit to cross-subsidise loss-making services;
extra profit could turn a loss-making firm into a profit maker ensuring
the good/service continues to be supplied
• Some consumers in the ‘elastic demand’ sub-market may be able to
afford the good at the lower price Pb
• Firm’s market is greater as it absorbs some lower-income consumers
• It can help firm’s use spare capacity (price can be lower at times
when there is high capacity and high when there is no spare capacity)
• May enable a firm to break into a new market at home or abroad and
make it more competitive
What impact does Price Discrimination have on Consumer Welfare?
• Higher prices for many people reduces their consumer surplus – an
example is “dual pricing” in insurance where loyal customers were charged more than new customers.
• Reinforces monopoly power of firms which can then lead to higher
prices in the long run and a loss of allocative efficiency
• Algorithms increase the potential to discriminate between consumers
– there is now widespread use of artificial intelligence driven price
discrimination leading to certain groups in society consistently paying
more (such as online hotel bookings).
• Multi-purchase or volume discount purchasing favours higher-income,
larger families at expense of single people. It can encourage food
waste which creates external costs
What is Third Degree Price Discrimination?
Third-degree price discrimination is a pricing strategy where a firm charges different prices to distinct groups of consumers for the same product or service.
