Price Discrimination occurs when a firm sells a good or service to different buyers at two or more different prices, for reasons not necessarily associated with cost. Price discrimination results in greater revenue for the firm. For example, Hotel rooms, airline tickets and professional services all offer different prices for different customers.
When you are paying for a seat on an airline, the airline offers different prices for different seats in different locations. Because some people are willing to pay more, the airline taps the extra consumer surplus by charging them more and providing a slightly different service. However, in economics there is no difference between a seat in business class or economy, they both provide the same type of service; taking people from location to another.
Examples of Price Discrimination
1. Airline travel and time of departure
Airlines charge different prices depending on the season, time of the flight and day of the week. During the peak holiday season, the prices will be higher because demand is greater and more inelastic.
2. Quantity Purchased
Many sellers offer quantity discounts for bulk purchases as a way to get buyers to buy more.
Companies often give coupons to selected consumers. For example, CVS sends coupons to regular customers to get special offers, e.g., 20% off selected items. These coupons are often highly targeted to your spending habits and previous purchases. This difference helps them segment the market based on purchase pattern and frequency.
4. Age Discounts
A popular way to segment the market is by age category, e.g., students often get discounts on travel and retail. Students have lower income than working adults and so are more sensitive to changes in price.
5. Choosing your seat early
Airplanes offer numerous ways to charge different prices for privileges like choosing a seat early or priority check-in. These perks are a way of extracting higher prices from those who want to pay for extras.
6. Three for Two offers
Bookstores often advertise that you can buy three books for the price of two to encourage consumers to buy a higher quantity.
Price Discrimination Conditions
Types of Price Discrimination
There are three degrees of price discrimination:
1. First Degree Price Discrimination
The seller knows and charges the maximum possible price every buyer is willing to pay. This creates a perfectly efficient market.
2. Second Degree Price Discrimination
The seller charges different prices based on either the quality or the quantity. Like discounts for bulk purchases (quantity) or charging more for first class seats (quality).
3. Third Degree Price Discrimination
The seller charges buyers different prices depending on their particular market segment, e.g. age profile, income group, time of use. This is legal except in certain circumstances like race or religion based discrimination. For example, many stores sell their own credit cards which offer consumers special discounts and rewards.