Conditions for Price Discrimination Exam Answer

A sample answer to this question. "Explain the conditions under which a business is able to engage in price discrimination"

Price discrimination is when a firm charges a different price to different groups of consumers for an identical good or service, for reasons not associated with costs.

Many different forms of price discrimination can take place such as 1st degree, 2nd degree, third degree, and the hurdle model of price discrimination. However, for all these to take place certain conditions must be met.

First the market must be a form of imperfect competition. If there was perfect competition then price discrimination would be not possible as a producer would not be able to control their prices. There must be some level of monopoly power to allow producers the ability to price set and not price take. For example Nurofen created higher prices on the same painkiller which had the same result. This was able to occur as there was asymmetric information among consumers and some monopoly power of nurofen.

Another condition for price discrimination is the prevention of re-sale. If consumers can simply buy a product at cheaper prices and sell it on for a profit to a consumer who would have paid a higher price then there is no price discrimination. This re-sale could take the form of second hand shops and re-sale ticket companies such as stub-hub. These companies capitalise on this arbitrage and re-sell the good creating a profit. Prevention of re-sale could be enforced in many different ways. For example students can only receive student discounts with a legitimate student ID. Furthermore airplane and train tickets are registered to one name and ID must be shown which certifies this.

A key condition for price discrimination to occur is the identification of different market segments. If this is possible different groups have different price elasticities of demand. Therefore the firm can charge different prices depending on the consumers sensitivity to price changes. For example they could charge higher for richer, inelastic consumers who continue buying no matter the price rise. The firm continues to gain profit as long as the marginal revenue is greater than marginal cost.

To gain knowledge of different groups of PED and different individual consume PED firms may have to gain information or market intelligence on consumers through means such as deep data digging in cookies and browser histories. Companies such as Amazon use this technique in order for them to suggest relevant items for each consumer with specialised deals put together based on individual consumer preference. Consumers leave a digital footprint every time they go online, this makes it cheaper and easier for many firms to engage in price discrimination.