PRICE DISCRIMINATION

Peter is a used car dealer and is known to charge higher prices for his cars to affluent clients, while he is known to reduce his price if he sees that a customer is not too well-off or unlikely to pay a high price. What Peter is indulging in is the most basic form of price discrimination.

Price discrimination is a selling tactic that charges different prices to customers for the same service or product. Here, the seller charges different prices to different groups of people, based on certain attributes.

For a price discrimination to be legal, the different price charged to a different group of people must be justified by the amount of effort required. At a wholesaler manufacturing level, it is more complicated to ascertain if a seller isengaging in price discrimination. To protect themselves from any unfair price discrimination, many purchasers ‘most favoured nation’ clauses in their purchasing contracts that protect them from any price discrimination by wholesalers and manufacturers. These clauses guarantee that the seller is offering their goods/services at the same price as they are giving to their other buyers.

There are three kinds of price discriminations in the market:

·       First degree discrimination is where the company charges the maximum possible price for each unit they sell.

·       Second degree discrimination is where customers are charged different prices depending on what they choose. For example, loyalty cards reward frequent buyers with discounts on future purchases. Or when coupons by fast food companies reward customers with a discount.   This is indirect price discrimination because the seller is allowing the consumer to choose what price they will pay.

·       Third degree discrimination is where an entire group is charged differently from the others. For example, student discounts at restaurants, travel/oyster cards for school children which are sold at a lower price or off-peak travel rail tickets being cheaper. This is also known as direct price discrimination.

Another way that firms practice price discrimination is when they offer slightly altered products, depending on a consumer’s ability to pay. For example, offering priority boarding ticket where consumer gets a shorter queue and better service within the same flight. Or when an airline charges higher price for seats which offer extra legroom on their flights. This is a kind of indirect segmentation when consumers who are willing to pay more are offered better choices.

Say that Sarah charges £7 for every music CD that she sells. If she has 100 customers and if she offers the same price to all, she will earn £7 * 100 = £700 revenue. With price discrimination, she can charge two different prices where students can buy the CD at £4 while adult would need to pay £10. Thus, her revenue would then be:

£10 * 35 = £350

£4  * 120 = £480

Total revenue= £830. Thus, the firm makes more revenue under price discrimination.

One can maximise profits under price discrimination if the seller sets output of products and price in such a way that MR=MC. If the market has two subsets with different elasticity of demand, then the firm can increase their profits considerably by setting different prices for both subsets, depending on the slope of the demand curve. Thus, the PED Price Elasticity demand for adults is inelastic and thus price is higher, while for students, prices will be lower as their demand is elastic.  Profit is maximum when MR=MC.

Link between marginal cost and price discrimination:

When the marginal cost of an additional traveller for a flight is very low, the airlines feels motivated to use price discrimination to sell all the tickets. Once a flight is soon to fly, the MC of an extra customer is very low. This validates price discrimination for the airline.

Some examples of price discrimination:

·       Discounts for buying train tickets in advance

·       Student discounts on rail journeys

·       Mobile phone deals which allow 100 text messages free