Price Discrimination

PRICE
DISCRIMINATIO
N Group 2
INTRODUCTION
 Pricing strategy where a seller charges different prices for the same product or
service to different customers.
 Maximize revenue by capturing consumer surplus (difference between what
consumers are willing to pay and what they actually pay).
 Objective:
 The aim of the monopolist applying price discrimination is to increase total
revenue and profits. By charging different prices in different markets, the
monopolist can make more money than by charging a single uniform price.
 Example:
 Airlines charge lower prices for flights booked well in advance and higher prices
for last-minute bookings.
ASSUMPTIONS
 Exists when the same product is sold at different prices to different buyers.
 Cost of production is either the same, or it differs but not as much as the difference
in the charged price.
 Product is basically the same, but it may have slight differences (for example,
different seats in a train).
 These factors give rise to demand curves with different elasticities in the various
sectors of the market of the firm.
 Common to charge different prices for the same product at different time periods.
 Necessary conditions:
 Market must be subdivided into sub-markets with different elasticities.
 Effective separation of sub-markets, so that no reselling can take place from a
low price market to a high price market
TYPES OF PRICE
DISCRIMINATION
Prof. A.C. Pigou has given the following three degrees of discriminating monopoly:
 First-degree: Perfect price discrimination.
 Second-degree: Prices vary by quantity/versions.
 Third-degree: Prices vary by consumer groups

MODEL
• Assume that the monopolist will sell his
product in two segregated markets, each of
them having a demand curve with different
elasticity.
• D1 has a higher price elasticity than
D2 at any given price
• total-demand curve D is found by the
horizontal summation of D1 and D2
• Aggregate marginal revenue (MR) is the
horizontal summation of the marginal-
revenue curves MR1 and MR2.
• The marginal-cost curve is depicted by the
curve MC.
• The total quantity to be produced is defined
by the point of intersection of the MC and
the aggregate MR curves.
• Two curves intersect at point ε, thus defining a
total output 0X.
• Charge a uniform price this would be P, and
his total revenue would be 0XAP.
• His profit would be the difference between this
revenue and the cost for producing 0X.
• Can achieve a higher profit by charging
different prices in the two markets.
• In each market he must equate the marginal
revenue with the MC.
• Marginal cost is the same for the whole
quantity produced
• Profit in each market is maximized by
equating MC to the corresponding MR
• MR1 = MC
• MR2 = MC
• Total profit is maximized when
• MC = MR1 = MR2
• MR in one market were larger, the monopolist
would sell more in that market and less in the
other, until the above condition was fulfilled.
• Graphically
• From the equilibrium point e we draw a
line perpendicular to the price axis.
• line cuts the marginal revenue MR1 at
point Ɛ1 and the marginal revenue MR2 at
point Ɛ2.
• From Ɛ1 and Ɛ2 we drop vertical lines to
the quantity axis, and we extend them
upwards until they meet the demand
curves D1 and D2
• Vertical lines define the output and price in
each market.
• In the first market the monopolist will sell
0X1 at a price P1, and in the second market the
monopolist will sell 0X2 at the price P2.
• Total revenue from price discrimination is
larger than the revenue 0XAP which would be
received by charging a uniform price P.
• PDEP2 is the additional revenue from selling
0X2 at price P2 which is higher than P, while
CBAD is the loss in revenue from selling 0X1 at
price P1 which is lower than P.
• Additional revenue from selling 0X2 at a higher
price more than offsets the loss of revenue
from selling 0X2 at a lower price, so that total
revenue from price discrimination is larger.
• The above case has been called third-degree
price discrimination by the British economist
Pigou.
• The increase in total revenue is achieved by
taking away part of the consumers’ surplus.
FIRST DEGREE PRICE
DISCRIMINATION
• First-degree discrimination, or perfect price
discrimination, occurs when a business charges
the maximum possible price for each unit
consumed.
• Because prices vary among units, the firm
captures all available consumer surplus for
itself or the economic surplus.
• In this case the demand curve also becomes
the MR curve of the monopolist.
The IPL auction
exemplifies first-degree
price discrimination as
franchises bid varying
amounts for players
based on their
perceived value and
the maximum they are
willing to pay, resulting
in each player being
sold at a unique price
tailored to the highest
bid.
SECOND DEGREE PRICE
DISCRIMINATION
• If the monopolist can negotiate and sell at
more than two prices (higher than P), for
example to sell 0X1 at P1, X1X2 at P2,X2X3 at
P3 and X3X at P, he will receive a still larger
part of the consumers’ surplus.
• This is called a second-degree price
discrimination.
Netflix employs
second-degree price
discrimination by
offering different
subscription plans with
varying features, such
as mobile, basic,
standard, and premium
tiers, allowing
customers to choose a
plan based on their
willingness to pay for
additional features like
higher video quality
and the number of
simultaneous streams.
THIRD DEGREE PRICE
DISCRIMINATION
• If the monopolist sold all 0X at P he would
receive 0XAP, and the consumers would
have a surplus of PAD.
• Assume now that the monopolist sells
0X1 at the price P1 and the remaining
quantity X1X at the price P.
• His total revenue will be that is, the
monopolist has managed to take the part
PBCP1 from the consumers’ surplus.
Airlines practice third-
degree price
discrimination by
charging higher prices
for tickets purchased
closer to the departure
date and offering lower
prices for tickets
booked well in
advance. This pricing
strategy segments
customers based on
their booking timing
and willingness to pay,
with last-minute
travelers typically
paying more compared
to those who book
early.
First-Degree Price Discrimination:
•Advantages:
• Maximizes profits.
• Extracts consumer surplus.
• Customized pricing.
•Disadvantages:
• Requires detailed consumer info.
• Hard to implement.
• Potential ethical concerns.
Second-Degree Price Discrimination:

•Advantages:
• Encourages bulk purchases.
• Increases sales volume.
• Flexible pricing options.
•Disadvantages:
• Complexity in setting price tiers.
• May alienate price-sensitive consumers.
• Possible consumer confusion.
Third-Degree Price Discrimination:
•Advantages:
• Targets different market segments.
• Maximizes revenue across segments.
• Easier to implement.
•Disadvantages:
• Requires market segmentation data.
• Risk of arbitrage.
• Potential for segment misclassification.
Questions:
How do businesses gather and use consumer information differently across first, second, and third-
degree price discrimination, and what are the key challenges and benefits associated with each
method?
What strategies do companies use to implement first, second, and third-degree price discrimination,
and how do these strategies impact consumer behavior and market segmentation?

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PRICE

 Second-degree: Prices vary by quantity/versions.

 Third-degree: Prices vary by consumer groups

Second-Degree Price Discrimination:

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