A2 Micro: Price Discrimination

Our updated presentation on price discrimination is available in three formats

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Most businesses charge different prices to different groups of consumers for the same good or service! This is price discrimination. Businesses could make more money if they treated everyone as individuals and charged them the price they are willing to pay. But doing this involves a cost – so they have to find the right pricing strategy for each part of the market they serve – their revenues should rise, but marketing costs will also increase.

It is important that you understand what price discrimination is, the conditions required for it to happen and also some of the economic and social consequences of this type of pricing tactic.

What is price discrimination?

Price discrimination occurs when a business charges a different price to different groups of consumers for the same good or service, for reasons not associated with costs.
It is important to stress that charging different prices for similar goods is not pure price discrimination. Product differentiation – gives a supplier greater control over price and the potential to charge consumers a premium price because of actual or perceived differences in the quality or performance of a good or service.

Conditions necessary for price discrimination to work

Essentially there are two main conditions required for discriminatory pricing:

o Differences in price elasticity of demand: There must be a different price elasticity of demand for each group of consumers. The firm is then able to charge a higher price to the group with a more price inelastic demand and a lower price to the group with a more elastic demand. By adopting such a strategy, the firm can increase total revenue and profits (i.e. achieve a higher level of producer surplus). To profit maximise, the firm will seek to set marginal revenue = to marginal cost in each separate (segmented) market.

o Barriers to prevent consumers switching from one supplier to another: The firm must be able to prevent “consumer switching” – a process whereby consumers who have purchased a product at a lower price are able to re-sell it to those consumers who would have otherwise paid the expensive price. This can be done in a number of ways, – and is probably easier to achieve with the provision of a unique service such as a haircut, dental treatment or a consultation with a doctor rather than with the exchange of tangible goods such as a meal in a restaurant.

o Switching might be prevented by selling a product to consumers at unique moments in time – for example with the use of airline tickets for a specific flight that cannot be resold under any circumstances or cheaper rail tickets that are valid for a specific rail service.
o Software businesses such as Microsoft often offer heavy price discounts for educational users. Office 2007 for example was made available at a 90% discount for students in the summer of 2009. But educational purchasers must provide evidence that they are students