Price Discrimination

Meaning and Degrees

Price Discrimination
• The theory of pricing under monopoly gives the impression that once
a monopolist fixes the price of its product, the same price will be
charged from all the consumers.
• A monopolist, simply by virtue of its monopoly power, is capable of
charging different prices from different consumers or groups of
consumers.
• When the same or somewhat differentiated product is sold at different
prices to different consumers, it is called price discrimination.
• When a monopolist sells an identical product at different prices to
different buyers, it is called a discriminatory monopoly.
Contd.

• Price discrimination refers to the practice of a seller to sell the same

product at different prices to different buyers.
• A seller makes price discrimination between different buyers when it
is both possible and profitable for him to do so.
• If the manufacturer of a refrigerator of a given variety sells it at ₹5000
to one buyer and at ₹5,500 to another buyer, he is practicing price
discrimination.
Contd.

• Consumers are discriminated in respect of price on the basis of their:

Income or purchasing power,
Geographical location,
Age,
Gender,
Quantity they purchase,
Their association with the seller,
Frequency of purchases,
Purpose of the use of the commodity or service.
Some Examples
Consulting physicians charge different fees from different clients on the
basis of their paying capacity even if quantity and quality of service
rendered is the same.
Price discrimination on the basis of age is found in railways, roadways and
airways: children between 3 and 12 years are charged only half the adult
rates.
Price discrimination on the basis of quantity purchased is very common. It
is generally found that private businessmen charge lower price (or give
discount) when bulk purchase is made.
The most common practice of price discrimination is found in entertainment
business, e.g. cinema shows, musical concerts, game shows, etc. Different
rates are charged from different class of audience.
Types of Price Discrimination

• There are three types of price discrimination:

i. Personal,

ii. Local,

iii. According to use or trade.

Contd.
Price discrimination is personal when a seller charges different prices
from different persons.
Price discrimination is local when the seller charges different prices
from people of different localities or places.
• For instance, producer may sell a commodity at one price at home and at
another price abroad.
Discrimination according to use occurs when different prices of a
commodity are charged according to the uses to which the commodity
is put.
• For example, the electricity is usually sold at a cheaper rate for domestic uses
than for commercial purposes.
Necessary Conditions for Price Discrimination

• First, markets are so separated that resale is not profitable.

 The markets for different classes of consumers are so separated that buyers of
low-price market do not find it profitable to resell the commodity in the high-price
market.
• Secondly, price elasticity of demand is different in different markets.
 If market is divided into sub-market, the elasticity of demand at a given price must
be different in each sub-market.
• Thirdly, the firm must have some monopoly power to control production
and price.
 The monopoly firm must possess some monopoly power over the supply of the
product to be able to distinguish between different classes of consumers and to
charge different prices.
 Degrees of Price Discrimination
• The degree of price discrimination refers to the extent to which a seller
can divide the market and can take advantage of market division in
extracting the consumer’s surplus.
• According to A. C. Pigou, there are three degrees of price
discrimination practiced by the monopolists:
• (i) first-degree price discrimination;
• (ii) second-degree price discrimination, and
• (iii) third-degree price discrimination.
First-degree Price Discrimination
• The discriminatory pricing that attempts to take away the entire
consumer surplus is called first-degree price discrimination.
• First-degree discrimination is possible only when a seller is in a
position to know the price each buyer is willing to pay.
• In this case, the monopolist can negotiate individually with each buyer
and sell each unit of output at its corresponding price, then he will
receive the entire consumers' surplus.
 Also known as 'take-it-or-leave-it'
price discrimination, because in
negotiating with each buyer the
monopolist charges him the maximum
price he is willing to pay under threat
of denying the selling of any quantity
to him: he offers each buyer a 'take-it-
or-leave-it' choice.
 In this case the demand curve also
becomes the MR curve of the
monopolist.
Second-degree Price Discrimination
• Price discrimination of the second degree would occur when a
monopolist is able to charge separate prices for different blocks or
quantities of a commodity from buyers and in this way he takes away
a part, but not all of consumer surplus from them.
• The second-degree price discrimination is also called ‘block pricing
system’.
• A different price is charged from different category of consumers.
 Thus, under the second degree price
discrimination a monopolist may
charge a high price for first block of
say 10 units, the medium price for the
additional block of 10 units, and a
lower price for additional 10 units of
a commodity.
 For example, a monopolist may
charge from a buyer a price of ₹50
per unit for the first 10 units, ₹40 per
unit for the next 10 units and ₹30 per
unit for the additional units of the
commodity.
 As a result, some consumer’s surplus
is left with the buyers.
• The second-degree price discrimination is feasible where:
a) The number of consumers is large and price rationing can be
effective, as in case of utilities like telephones, natural gas and also
consumer durables;
b) Demand curves of all the consumers are identical, and
c) A single rate is applicable only for a group of large number of
buyers.
Third-degree Price Discrimination
• Price discrimination of the third degree is said to occur when the seller divides
his buyers into two or more than two sub-markets or groups depending on the
demand conditions in each sub-market and charges a different price in each
sub-market.
• The price charged in each sub-market depends upon the output sold in that sub-
market and the demand conditions of that sub-market.
• A common example of such discrimination is found in the practice of a
manufacturer who sells his product at a higher price at home and at a lower
price abroad.
• Again, the third degree price discrimination is found when an electric company
sells electric power at a lower price to the households and at a higher price to
the manufacturers who use it for industrial purposes.