Often do we come across situations when we find that a single producer sells his product at different prices to different buyers or in different markets. This practice of charging different prices to different buyers or in different markets for the same product is called Price discrimination.
According to British economist Joan Robinson, “the act of selling the same article, produced under a single control, at different prices to different buyers is called Price discrimination.”
Price discrimination is a practice firms employ when they charge consumers different prices for the same good in order to earn higher profits. Price discrimination is made possible because of varying utility derived from the consumption of the same good and varying price elasticity of demand. There are 3 types of price discrimination, namely: first-degree price discrimination (perfect price discrimination), second-degree price discrimination and third-degree price discrimination.
A firm is said to have practiced first-degree price discrimination when it charges each consumer a different price. Each different price corresponds to the value each individual consumer places on the good. Second-degree price discrimination occurs when firms charge lower per unit prices as quantity purchase by consumers increases. Firms should practice second degree price discrimination because the good or service offered will be made more available to different groups of consumers. Third-degree price discrimination is practiced when a firm charges different prices to different identifiable groups for the same good or service. These groups are identifiable based on, for example, age or sex. Three requirements must be met before a firm can practice third-degree price discrimination: there must be varying sensitivity to price among the different groups, firms must identify the different groups explicitly and no resale of goods can be made among the groups themselves. For example, EasyJet charges different prices for similar tickets over the internet. The seats that are booked early are cheaper compared to those that are booked late. This is the third degree price discrimination where consumers pay different prices for the same commodity the difference being the time that each individual booked the ticket. Passengers traveling on the same plane pay different prices for their seats in the plane. Those consumers who come late are willing to pay the high prices so as not to wait for the next freight.
The person or firm practicing price discrimination is the Discriminating Monopolist. Price discrimination may take any of these three forms :
- Personal Price-discrimination: i.e. different prices may be charged to different buyers for the same product, may be depending upon the individuals ability to pay.
- Regional Price-discrimination: i.e. different prices may be charged for the same product in different local markets. Local or regional price-discrimination depends on the differences in elasticities of demand for the product in different markets.
- Trade Price-discrimination: i.e. different prices may be charged for the same product depending upon the use to which the product is applied. e.g. a relatively lower price is charged for a unit of electricity when used for industrial consumption purpose as compared to the price charged for the same unit of electricity for the purpose of domestic consumption.
Price-discrimination is possible under following conditions :
- Imperfect Competition : Price-discrimination is not possible under perfect competition because under perfect competition each firm is a price taker and we also assume perfect knowledge on the part of buyers about market conditions. Hence a producer cannot charge different price for the same product to different buyers. Therefore price-discrimination can only be practiced under imperfect competition.
- Absence of Resale possibility : The fundamental condition which must be fulfilled if discrimination is to take place is that there should be no possibility of resale from one consumer to the other. Now if the same commodity is sold to Mr. A at 10$ and to Mr. B. at 9$ and if the buyers are interrelated then B will buy both the units at the price of 9$ each and resell it to A. In that case the monopolist will not be able to practice price-discrimination.
- Differences in Elasticity of demand : Perhaps the most important factor which promotes price discrimination is the prevalent differences in elasticity of demand for the product. It is due to differences in elasticity of demand for the product displayed by different consumers or in different regional markets that price-discrimination has become possible. In a market where demand for the product is relatively inelastic, the monopolist will charge a relatively higher price.
- Relative immobility of buyers : There should prevail no possibility of transferring the unit of demand from the high priced market to the low priced one or else it will be difficult for the monopolist to practice price-discrimination.
- Personal Services : In case of services which require personal touch and which are not subject to resale it is easy to practice price discrimination e.g. doctors, lawyers, hair-dressers, beauticians, auditors etc. can very conveniently practice price-discrimination.
- Regional distances and frontier barriers : Regional distances account for transport cost and so also inter-regional exchanges involve tariffs and duties. These factors enable the monopolist to charge different prices in different regional markets for the same product and encourage price-discrimination.
- Consumer’s Peculiarities : Price-discrimination takes place due to some of the peculiarities of the consumers:
- Ignorance : The consumer may be ignorant of the price charged by the monopolist for the same product to the other consumers.
- Indifference : The consumers do display the tendency to ignore minor price differences e.g. if Mr A is asked to pay 50$ for the product and Mr. B has paid 51$ then B may not bother much about this price difference. This attitude of indifference with regard to different prices charged for the same product to different buyers encourages the monopolist to practice price-discrimination.
- Illusion : The consumers entertain some false notions. i. e. there is the tendency to believe that different price implies inherent qualitative differences in the product. Such beliefs encourage the policy of price-discrimination.
Advantages of Price Discrimination to Firms – Firms that practice price discrimination get higher revenues as a result of charging different prices to different consumers for the same commodity. Some firms are likely to run bankrupt in absence of price discrimination. These are firms that cannot establish a certain price that can help them make normal profits. Price discrimination helps such firms to remain in operation since they can make some profit. Through price discrimination, firms are able to manage demands for a commodity that has higher demand at any given time. For example, a train might charge higher prices during the rush hour to avoid congestion and charge lower prices during off-peak. When the price of a train is higher at a specific time, some individuals will prefer to travel later when the price goes down. This reduces overcrowding during rush hours and those who travel at such times benefit from less congestion.
Advantages of Price Discrimination to Consumers – When a firm charges different prices to different groups of people, some consumers enjoy cheaper prices. Firms tend to cut prices for certain groups of people who are sensitive to prices or those whose income is low. Students and old people are examples of such people who are likely to enjoy cheaper prices. Any group that a firm perceives to be poorer than the average consumer enjoys lower prices. When firms that could have been closed as a result of losses continue running due to price discrimination, the consumer benefits in that he or she has several choices of goods and services. When firms increase revenue, they are likely to spare some money for research and development. These are likely to increase the quality of the commodity which at the end of the day benefits the consumer. In firms such as the train company, those individuals who pay high prices are likely to enjoy comfort due to less congestion.
The practice of price discrimination remains a double edged sword. On one hand, it may seem beneficial because more consumers who otherwise might be priced out from previous higher price can now consumer the good. But on the other hand, social and moral issues like unfairness and privacy may entail. There are also many other sound justifications as to why firms should or should not price discriminate: able to identify consumers who are willing to pay more and the issue of the loss of consumer surplus. Whether or not firms should price discriminate is highly subjective and varies from case to case because of varying benefits and costs to society.