Price Discrimination in Economics – Part Two

In the first part, you should have learnt what price discrimination was, and how it is made possible. Now, we will go further, and investigate the different types of price discrimination, as well as its effects.

Different Degrees of Price Discrimination

There can be said to be three main degrees of price discrimination. The first – and highest – degree of price discrimination takes place when a firm charges a different price to each and every customer, for the same exact good. This generally takes place in markets that involve haggling and negotiation; the negotiation of prices with a taxi driver is a perfect example of first degree price discrimination. Tourists in third world countries are regularly charged higher prices for taxis than local consumers. Other examples could be an auction, or buying goods from street hawkers. One should note that with the first degree of price discrimination, it is not as important to split consumers into clearly discernable groups, as each consumer (theoretically) pays the maximum price they are willing to pay. Thus, there is no consumer surplus at all in this form of price discrimination.

The second degree of price discrimination generally occurs when the price per unit of a good is different depending on how many units are bought. For example, a box of ten chocolates could be sold for nine times as much as a single chocolate, reflecting the cheaper unit cost of a chocolate when buying the box. This form of price discrimination generally discriminates against those who only need small quantities of the good, by charging them higher costs.

The third and final degree of price discrimination is the most frequent form of price discrimination: it occurs when different prices are charged by separating the market. The separation usually occurs in one of two ways – by time, or by location. Mobile phone operators often have different costs for calls during the day and the night – this is price discrimination, where the market is separated by time. The same goes for theme parks that sell cheaper tickets in the afternoon than in the evening. As for geography, multi-national companies can easily charge different prices for goods in different countries, depending on their popularity and how much consumers are willing to pay for them.

Price Discrimination: Right or Wrong?

Perhaps the most obvious effect of price discrimination is on the consumers and the firms. Consumers are generally negatively affected, as they lose consumer surplus – consumer who previously would have had this consumer surplus have to pay higher prices for the same goods or services than they would have paid before. However, the firms gain out of this loss, as they make more profit. The firms could then use this profit to expand their operations and achieve lower average costs by using economies of scale, and thus sell the goods at a lower price in the long run.

Most positive arguments of discrimination involve the firms using their profits in ways that are beneficial to poorer groups of consumers and society. One school of thought holds that the firms could use their extra profits to subsidise essential goods – such as medical services – for poorer members of society, thereby pricing them into the market. Similarly, the firms could use their profits to subsidise other services that do not make a profit, but have important social consequences. For example, a transport company could use any profits made of luxury passengers to subsidise bus services in rural areas.

Such arguments, however, generally depend on the willingness of companies to use their profit in ways that are not directly beneficial to themselves, and thus generally rely on the goodwill of companies. It is my personal opinion that this is an inherent flaw of these arguments, unless the companies have something to gain that is worth more than the money they spend.

However you view price discrimination, you should now have a basic understanding of its workings.