Price discrimination

Price discrimination is a common business strategy which attempts to increase (or maximise) profits by charging different prices for the same product.  As well as help generate additional profits, price discrimination can help a firm achieve other business objectives, including gaining revenue and helping ensure survival.

There are various 'degrees' of price discrimination, including:

First degree discrimination

First degree discrimination means charging a different price for every good sold. If the firm discriminates with new prices it gains consumer surplus which it converts into producer surplus.

Price discrimination

In this way producer surplus can be increased as more prices are added. But it is very difficult to apply in practice as it would involve a very complex calculation for price and it would be relatively easy for a consumer who pays a higher price to find ways round the strategy.

Information failure means that this policy is unlikely to work in practice.

Second degree discrimination

Second degree discrimination means charging different prices for different quantities – so, unit prices for single products will be higher than those contained in multi-packs.

Third degree discrimination

Third-degree discrimination is the most common type and occurs when different sub-markets can be identified.

Price discrimination

Once identified, each sub-market must have a different PED. When PED is low and inelastic, profit maximising price is high.

But when PED is high and elastic, profit maximising price is much lower.

When sub-markets can be kept apart, say through time or place, discrimination is possible, as with peak-time travel tickets which are sold at higher prices than off-peak tickets.

In this example, profits from separating a market into an inelastic submarket and an elastic one - are greater than from combining the market. For convenience, MC is assumed constant, and equal to AC – profit maximisation in each market is where the MR for each sub-market equals the ‘common’ MC.

Video on price discrimination

Here, super-normal profits ‘X’ plus ‘Y’ are greater than ‘Z’ – so price discrimination is beneficial.

Price discrimination is a very common strategy, and can be employed whenever the above criteria can be met. Public transport and energy supply are two common examples.

Rail and air operators can charge different prices according to date and time of travel, whether child or adult, and whether business or tourist 'class'.

However, not all of the price differences are pure discrimination - business and tourist class travellers are likely to experience a different quality of service, even though the travel aspect might be identical.

Energy suppliers can also differentiate according to time (peak and off-peak) an whether domestic or business users.


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Price discrimination

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