theme 3 : price discrimination

monopoly engaging in a policy of price discrimination explanation

• occurs when a firm charges a different price to different groups of consumers for an identical good or service for reasons not associated with the costs of production

• important to stress that charging different prices for similar goods is not price discrimination

3 conditions required for price discrimination to work

• monopoly power

• elasticity of demand

• separation of the market

monopoly power explanation

• firms must have some price setting power

• so we don’t see price discrimination in perfectly competitive markets

elasticity of demand explanation

• must be a different price elasticity of demand for the product from each group of consumers

• allows the firm to extract consumer surplus by varying the price leading to additional revenue and profit

separation of market explanation

• firm must be able to split the market into different sub-groups of consumers and then prevent the good or service being resold between consumers

• costs of separating the market and selling to different sub-groups must not be high

examples of price discrimination

• cinemas and theatres cutting prices to attract younger and older audiences

• student discounts for rail travel, restaurant meals and holidays

• car rental firms cutting prices at weekends

• flights and holiday accommodation prices in term time / school holiday

price discrimination demand curves

• inelastic when the good or service is needed for example a train at peak travel time - you might not be bale to get a later train as you’d be late for work

• elastic when the good or service is not needed as desperately for example trains at later times in the day such as 3pm may be cheaper - people who use the trains for leisure could therefore chose the cheaper train

on a price discrimination graph where is the MC curve

• MC is equal to AC so the curve is horizontal across the graph

• is the demand curve and therefore the marginal revenue curve that differs depending on whether it is inelastic or elastic

aims of price discrimination

• main aim is to increase the total revenue and / or profits of the supplier

• helps them to offload excess capacity and can also be used as a technique to take market share away from rival firms

• some consumers may benefit from this type of pricing - with one price they might not have been able to afford a product whereas these prices are now ‘priced into the market’

• for most consumers however the price they pay reflects pretty closely what they are willing to pay

• in this respect price discrimination seeks to extract consumer surplus and turn it into producer surplus (or monopoly profit)