What is price discrimination?

Price discrimination happens when a firm charges a different price to different groups of
consumers for an identical good or service, for reasons not associated with costs of supply.
Price discrimination takes us away from the standard assumption in that there is a single
profit-maximising price for the same good or services.
Nearly all businesses make use of dynamic pricing methods where prices are heavily
determined by the strength of demand and consumers’ willingness & ability to pay. Price
discrimination is also known as yield management.

What are the main conditions required for a business to use price discrimination?
Firms must have sufficient power: Monopolists always have pricing power – they are price
makers not takers
Identifying different market segments: There must be groups of consumers with different
price elasticities of demand
Ability to separate different groups: Requires information on the purchasing behaviour of
consumers – often achieved by accumulating data on previous buying patterns
Ability to prevent re-sale (arbitrage): No secondary markets where arbitrage can take place
at intermediate prices - limiting sales might be done by using age-restrictions, ID cards and
so on
Price discrimination does not happen in perfectly competitive markets. It is only a feature of
imperfect competition where firms have some discretion / power over the prices they charge.

What are the main aims of price discrimination?

Providing that extra units can be sold for a price above the marginal cost of supply, price
discrimination is an effective way to increase revenue and profits
To increase total revenue by extracting consumer surplus and turning it into producer surplus
To increase total profit providing the marginal profit from selling to customers is positive
To generate cash-flow especially during a recession
To increase market share and build customer loyalty
To make more efficient use of a firm’s spare capacity
To reduce waste and cut the cost of keeping products in stock / storage

What are the main advantages from price discrimination?

It makes fuller use of spare capacity leading to less waste and unsold stock. There are
potential environmental benefits from this.
Helps generate extra cash flow for businesses which can ensure survival during a
recession / tough economic times.
Can help fund the cross-subsidy of goods and services – for example premium prices for
some can fund discounts for other groups perhaps living on lower incomes.
Higher monopoly profits can finance research and development spending which then drives
improved dynamic efficiency.

What are some disadvantages from price discrimination?

Price discrimination operates mainly in the interests of producers as they extract consumer
surplus and turn it into extra supernormal profit
Can be used as a pricing tactic to reduce competition and reinforce the market dominance of
leading firms
May lead to manipulation of groups with a price inelastic demand, not all of whom are on
high incomes
Can be viewed as unfair to certain groups, for example there is some evidence of
businesses using gender pricing on selected products
An example of a discriminatory monopoly is an airline monopoly. Airlines frequently sell
various seats at various prices based on demand. When a new flight is scheduled, airlines
tend to lower the price of tickets to raise demand.