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What is price discrimination?
Price discrimination involves charging a different price to different groups of people for the same good. For example – student discounts, off peak fares cheaper than peak fares.
What is first degree price discrimination?
This involves charging consumers the maximum price that they are willing to pay. There will be no consumer surplus.
What is second degree price discrimination?
This involves charging different prices depending upon the choices of consumer. For example quantity, time period, collecting coupons
What are examples of second degree price discrimination?
After 10 minutes phone calls become cheaper.
Electricity is more expensive for the first number of units. For a higher quantity of electricity consumed the marginal cost is lower.
Loyalty cards reward frequent buyers with discounts on future products.
If you collect coupons from a newspaper you can get a discount.
What is 2nd degree price discrimination also known as?
2nd-degree price discrimination is sometimes known as ‘indirect price discrimination’ because the firm allows consumers to choose which price they will pay. Some choices are offered cheaper because they impose costs on consumers (e.g. collecting coupons, buying in bulk or unsocial hours.
What is 3rd degree price discrimination?
This involves charging different prices to different groups of people.
What are examples of 3rd degree price discrimination?
Student discounts,
Senior citizen railcard
Peak travel/ off-peak travel
Cheaper prices by the time of the day (e.g. happy hour’s in pubs – usually earlier on in evening where demand is lower.
What is 3rd degree price discrimination also known as?
3rd degree price-discrimination is sometimes known as direct price discrimination. Because a firm directly sets different prices depending on distinct groups of consumers (e.g. age)
What does 3rd degree price discrimination involve?
Third Degree Price Discrimination involves charging a different price to different groups of consumers for the same good. These groups of consumers can be identified by particular characteristics such as age, sex, location, time of use.
What is 3rd degree PD like in the real world?
In the real world, third-degree price discrimination is quite common.
What does a firm need to practice price discrimination?
Ability to set prices. Some market power.
Ability to segment different classes of consumers (e.g. rail card to prove you are a senior citizen)
Ability to prevent resale. E.g. stop adults using student tickets.
What is indirect price discrimination?
The alternative is indirect price discrimination where consumers can choose depending on their behaviour, e.g. bulk buying gets lower average cost.
Draw a diagram for price discrimination for train tickets and explain.
If you buy on the day, tickets are usually more expensive. If you book 7 days in advance and stick to a specific time of the day, the price is lower.
On the same train, customers can be paying different prices for the same ticket.
What are examples of 3rd degree PD?
Students frequently get a 10% discount in shops and restaurants
Pensioners get discounted bus and train tickets. up to 33% cheaper
Book in advance - usually they are much cheaper than buying on the day. because customers who buy in advance are usually more price sensitive. have time to look for alternatives. Businessmen who buy on day, probably have higher income, but also consider train journey more of necessity – thus, their D is P inelastic.
A nightclub may offer a discount to female consumers on certain nights.
Why are students given 10% discount?
With lower-income, students tend to be more sensitive to prices. Their demand is price elastic.
Therefore, by cutting prices for students, a firm is able to increase sales and revenue, but still, keep relatively higher prices for other adults who have more inelastic demand.
what is product versioning?
A variance of price discrimination occurs when firms sell slightly different products.
E.g. first-class tickets are more expensive because the firm can offer a better service. However, first-class tickets also take advantage of different elasticities of demand. Businessmen who pay first class will have a more inelastic demand and so willing to pay higher prices to get a slightly better product
What is the idea behind price discrimination?
Charging different prices to different groups of consumers is known as price discrimination.
The idea is that if different segments of the market have different price elasticities of demand, then the profit maximising price will be different for the alternative groups.
Why are students more sensitive to prices?
Students typically will be more sensitive to prices.
This is because they have lower disposable income and so a small increase in price can make a good unaffordable.
Adults with full-time job are less price sensitive because they have higher income.
Draw a diagram showing elasticities for adult and students. And explain
For firm to maximise profits, they will set a price where marginal revenue = marginal cost.
For adults, profit max. price is £9.99. But, at that price, D from students would be v. low. If you reduce price to £4.99 for students you are able to sell more to students, but still keep selling at high price to non-students.
In this way, firm gets best of both world – high price to adults, & increased sales to students. This way it can make more profits by offering different prices to the different groups of consumers.
(WIthout price discrimination, the firm may charge an average price of £7.99)
What are conditions necessary for price dissemination?
A firm must be able to separate the markets. Firms can segment students by age or student cards.
The different markets must have different elasticities of demand.
The costs of separating markets must be low.
The firm must be able to prevent resale, e.g. students buying goods for adults.
Why do music firms offer student discount?
The student generation is less amenable to the idea of ‘paying for music’.
Many students are more used to a culture of getting music for free.
A cheap offer makes it more attractive to make a regular payment and get into the habit of paying for music.
Spotify will hope that many who join service as students will become loyal life-time members and when the price goes up to a regular £9.99 in three years time they will have strong brand loyalty and keep paying.
Why do banks offer student discount?
On a similar theme, many banks offer special student bank accounts.
These accounts may not be particularly profitable for banks, but they will hope that a student who signs up will stay for life.
Therefore, students are seen as an investment for the future.
Why not discounts for other low-income groups like the unemployed?
In theory, firm could offer discounts to groups of people who can prove they are u/e or claiming benefits. Their income is likely to be lower than students and even more price elastic.
However, this starts to bring in non-economic factors. The u/e /benefit recipient will not like stigma of getting out an u/e letter to get 10% off a restaurant meal.
Also, other customers may slightly resent if they felt they were subsidising ‘benefit recipients.’
Sometimes in past football clubs, with high local rates of u/e, have given discounts to the unemployed.
What is example of product versioning?
Priority boarding tickets. Same flight but for a premium, you get a shorter queue.
Organic coffee / fair trade coffee
Extra legroom on aeroplanes
First-class/second class
What is product versioning an example of?
This is a form of indirect segmentation. By offering slightly different choices, the firm is able to separate consumers who are willing to pay higher prices.
What do firms have to be to PD?
Firm is a price maker.
The firm must operate in imperfect competition; it must be a price maker with a downwardly sloping demand curve.
What do firms have to be to PD?
Separate markets.
The firm must be able to separate markets and prevent resale. E.g. stopping an adults using a child’s ticket. Prevent business travellers from buying discount tickets.
What do elasticities have to be to PD?
Different elasticities of demand.
Different consumer groups must have elasticities of demand. E.g. students with low income will be more price elastic and sensitive to price.
Business travellers will have more inelastic demand.
What do costs have to be to PD?
Low admin costs. It must be relatively cheap to separate markets and implement price discrimination.
Draw a simple diagram for PD and explain.
W/o PD, firm charges one price £7 * 100 = £700 revenue
WIth PD, the firm can charge two different prices:
£10 * 35 = £350
£4 * 120 = £480
Total revenue = £830. Therefore, the firm makes more revenue under price discrimination.
Where is profit maximisation under PD?
To max. profits a firm sets output and price where MR=MC. If there are 2 sub markets with diff. elasticities of demand. Firm will increase profits by setting diff. prices depending upon slope of demand curve.
Therefore for a group, such as adults, PED is inelastic – the price will be higher
For groups like students, prices will be lower because their demand is elastic
Draw a diagram of PD with 3 mkts and explain.
Profit is max. where MR=MC. W/o PD, there would just be 1 price set for the whole market (A+B). Would be price of P3.
However, PD allows firm to set diff. prices for segment A (inelastic demand) and segment B (elastic demand)
Because demand is price inelastic, segment (A) will have a higher profit maximising price (P1)
In segment (B) demand is price elastic, so the profit maximising price is lower.
Advantage of PD - increase revenue
Firms will be able to increase revenue.
PD will enable some firms to stay in business who otherwise would have made a loss.
E.g. PD is important for train companies who offer different prices for peak and off-peak. W/o PD, they may go out of business or be unable to provide off-peak services.
Advantage of PD - increase investment
Increased investment.
These increased revenues can be used for research and development which benefit consumers
Advantage of PD - lower prices
Lower prices for some. Some consumers will benefit from lower fares.
E.g. old people benefit from lower train companies; old people are more likely to be poor.
Also, customers willing to spend time in researching ‘special offers’ and travelling at awkward times will be rewarded with lower prices.
Advantage of PD - manage demand
Manages demand.
Airlines can use price discrimination to encourage people to travel at unpopular times (early in the morning)
This helps avoid over-crowding and helps to spread out demand.
Advantage of PD - stops bankrupt
Allows unprofitable business to avoid going bankrupt.
In some cases, may be poss. that there is no 1 price that would enable a firm to make normal profits. (i.e. average costs would always be higher than demand curve)
However, PD may enable the firm to turn a loss into a small profit. means that a business activity can keep going, rather than closing down.
This is obviously beneficial for consumers because it increases their choice of goods and services.
example might be train services. W/o PD (off-peak, peak) train companies would make bigger loss & may be discontinued.
Advantage of PD - avoid congestion
PD is one way to manage demand.
If there were no price discrimination rush hour trains would be more overcrowded.
PD gives incentive for some people to go later in day.
This means that those who have to travel at rush hour benefit from less congestion.
Advantage of PD - low income
Low-income consumers may be able to benefit from cheaper prices.
One form of indirect PD is to offer lower prices to consumers who collect coupons.
This imposes a cost on consumers (time to collect).
So if consumers are time-rich and money poor, they can take advantage of lower prices.
disadvantages of PD - higher prices for some
Under price discrimination, some consumers will end up paying higher prices (e.g. people who have to travel at busy times).
These higher prices are likely to be allocatively inefficient because P > MC.
Disadvantages of PD - consumer surplus
Price discrimination enables a transfer of money from consumers to firms – contributing to increased inequality.
Disadvantages of PD - potentially unfair
Those who pay higher prices may not be the poorest.
For example, adults paying full price could be unemployed, senior citizens can be very well off.
Disadvantage of PD - costs
There will be administration costs in separating the markets, which could lead to higher prices.
Disadvantages of PD - predatory pricing
Profits from price discrimination could be used to finance predatory pricing.
Importance of marginal cost in PD?
In markets where the marginal cost of an extra passenger is very low, the firm has an incentive to use price discrimination to sell all the tickets.
This is why sometimes prices for airlines can be very low just before their date.
Once the company is due to fly the MC of an extra passenger will be very low. Therefore this justifies selling the remaining tickets at a low price.
Examples of PD?
Student discounts on trains
Discounts for buying train tickets in advance
Discounts for travelling at off-peak time
Lower unit cost price for buying high quantity.
Phone deals which give 100 texts free.
Initially, units of electricity are set at one tariff, but for higher quantity, price is lower.
What are the conditions for PD?
First must have price making power, therefore barriers to entry likely to exist
Firms should be able to identify and separate different groups of customers by understanding their PEDs.
No seepage – when customers can buy at a lower price from the firm and re-sell it themselves
What does price dissemination mean for the seller?
Price discrimination allows the seller to charge different prices for the same product to different consumers.
Therefore, it allows the seller to charge higher prices to people who are more likely to pay them, and at the same time, charge lower prices for those who are more sensitive to price.
What is surplus?
Surplus is a measure of welfare. Consumer surplus is a measure of consumer welfare and producer surplus is a measure of producer welfare.
Consumer surplus: defined as the difference between the current market price and the maximum price consumers are willing to pay
Producer surplus: defined as the difference between the market price and the minimum price the producer is able to sell at.
What does PD do to surplus?
PD transfers surplus from consumer to the producer
Consumer surplus: defined as the difference between the current market price and the maximum price consumers are willing to pay
Producer surplus: defined as the difference between the market price and the minimum price the producer is able to sell at.
Therefore, when prices are increased by the seller, consumer surplus falls and producer surplus rises.
In fact, the surplus is transferred from the consumer to the producer.
Is 1st degree PD likely?
In reality, this is pretty much impossible because the seller would need perfect information to achieve this.
Gathering info. is very costly, which would eat into the firm’s profits – therefore, it is unlikely a firm will ever benefit from first degree price discrimination.
What is the price changed based on in 2nd degree PD?
This is often occurs in wholesale markets. Discounts are provided to those who buy large quantities of a good. The more you buy, the less you pay per unit.
The price charged is based on the quantity you buy. This encourages larger orders to be made.
Those who do not want to bulk buy, will instead pay the market price.
Who do firms raise prices for in 3rd degree PD?
Firms raise prices for groups with lower elasticity of demand. Firms lower prices for groups with higher elasticity of demand.
Profit maximisation occurs at the point MC=MR (like always).
The firm is better able to profit maximise because they produce more revenue from each target group than without any discrimination.
What are advantages of PD to society ? (Cons. Surplus)
Increased consumer surplus: Price discrimination can make it possible for customers with lesser purchasing power to receive goods or services at a cheaper cost, boosting their consumer surplus and enhancing their welfare.
What are advantages of PD to society ? (Redistribution)
Redistribution of income: Price discrimination in some cases means higher income groups pay higher prices for products than lower income groups. This means price discrimination has redistributive properties and therefore may benefit income inequality.
What are advantages of PD to society ? (Efficiency)
Improved market efficiency: Price discrimination enables businesses to better match prices with consumers' willingness to pay, which improves market efficiency by more effectively allocating resources.
What are advantages of PD to society ? (Business)
Increase income for businesses: By capturing distinct market niches at various price points and allowing for increased profitability and potential investment in R&D, price discrimination can assist businesses in generating additional income. This can result in better dynamic efficiency.
What are disadvantages of PD to society ? (Cons. Welfare)
Reduced consumer welfare: Price discrimination can cause certain customers to pay more for the same goods than others, lowering overall consumer welfare and sometimes resulting in imbalances.
What are disadvantages of PD to society ? (Exclusion)
Potential exclusion: Price discrimination can prevent some customer groups from accessing certain goods or services because they cannot afford the higher prices imposed for those segments.
What are disadvantages of PD to society ? (Inefficiency)
Inefficiency and market distortion: Because businesses concentrate on market segmentation and profit maximisation rather than manufacturing goods efficiently, price discrimination may lead to market distortions. A loss of total economic welfare and a misallocation of resources may result from this.
What are disadvantages of PD to society ? (Competition)
Diminished competition: Price discrimination can increase the market dominance of established businesses, making it harder for newcomers to compete and lessening total market competition.
Draw diagram of 1st degree PD.
first degree price discrimination - the firm has perfect knowledge about every consumer - so firms charge each and every consumer according to their maximum value of the product - this allows firms to extract every last bit of consumer surplus in the market - the result is even greater profits for the producer
Draw diagram of 2nd degree PD.
second degree price discrimination - the seller charges multiple prices according to the quantity you buy - for example buying a product wholesale will reduce its price compare to buying 1 unit
Draw a diagram of 3rd degree PD.
third degree price discrimination - firms price according to the elasticity of demand among different groups of people - on the left we have the group with inelastic demand - these people are not sensitive to price - this could be people taking the train to work, for example - on the right we have the group of people who are demand elastic - these people are sensitive to price, and the firm generates more income if the price in this segment is decreased - this could mean lower prices for leisure travellers on the train
Give 3 reasons why a monopoly firm would want to price discriminate: (Rev. & Profit)
Increased Revenues and Profits: Due to price discrimination, the monopoly firm is able to charge higher prices to clients with higher willingness-to-pay. The company can extract more income and boost its overall profitability by segmenting the market and setting different rates for various groups.
Give 3 reasons why a monopoly firm would want to price discriminate: (Mkt. Share)
Higher Market Share: By using price discrimination, the company can target specific market segments and modify its pricing approach to increase sales in each one. As a result, the company is able to enhance its market power and capture a bigger share of the market. Higher market share might be beneficial to the firm’s long-term survival
Give 3 reasons why a monopoly firm would want to price discriminate: (Barriers to Entry)
Creation of Barriers to Entry: Price discrimination can serve as a barrier to entry for potential competitors. Because of a lower average cost of production, a monopoly firm may be able to reduce prices for certain groups of customers and stay in business. For example, a monopoly airline might sell cost price plane tickets at off-peak times of the year and still stay in business. This pricing tactic makes it more difficult for new entrants to survive, thus reducing the monopoly’s long-term competition.
