price discrimination

first degree price discrimination

• when a firm is able to sell and charge each customer the maximum price they are willing to pay

third degree price competition

• when a firm charges different prices for the same good or service to different customers in different market segments based on their willingness to pay

• this enables a firm to increase their supernormal profit further

• enables monopolies to appropriate consumer surplus

conditions required for price discrimination

• market needs to be split into distinct groups

• prevent resale

• firm must be a price maker and therefore some market power

• must face different demand curves for different sub-markets

using a diagram explain how a rail company can split a market into two sub-sections and thus charge each segment a different price

• rail market can be split into commuters and leisure travellers

• they have different price elasticities of demand

• commuters are less price sensitive (relatively more price inelastic) due to needing to travel for work

• leisure travellers are more price sensitive (relatively more price elastic) due to being more flexible about when they want to travel as it is not a need

• assuming that both markets have the same cost of production we get the prices Pc and PL with PL being much higher

advantages of price discrimination

• cost-subsidisation

• manage demand - airlines encourage people to travel at unpopular hours

• low income consumers can benefit from lower prices

• increases revenue which can lead to more investment into R&D or innovation resulting in increased dynamic inefficiency

• greater economies of scale due to greater quantity of output which may lead to lower prices for consumers in the future

disadvantages

• loss of welfare as consumer surplus is transferred to producer

• inequitable as some customers pay more than others

• allocative inefficiencies - P>MC

• anti-competitive pricing

  • prices are very low in price elastic market it can price out competitors leaving the firm with pure monopoly power