Phyo Phyo (1708297)
University of Buckingham
Price discrimination refers to a method which comprises of a person selling a good or the firm charging different prices for the same customers on the same commodity or a product. Price discrimination is one of the methods of competition which is used by the firm, and it brought into existence by businesses in the process of ensuring that there is an improved profit from the differences in the demand and the supply of the goods from the consumers. It is evident that a company can promote and increase its profits by charging the maximum amount of money for the same goods to each customer who comes to purchase it. (Bergemann, Brooks and Morris, 2015)
One of the determining factors as to whether a customer will buy the particular product at the given price is the willingness of the customer to pay or buy that specific product. However, there is a challenge in determining the amount of money that a specific firm will charge its consumers for various goods and services. Therefore, for the price discrimination strategy to succeed, the business must be in a position to identify and understand the basis of a customer and their needs and therefore the particular transaction must be familiar with the different types of price discrimination and especially those which are used to economics. There are three different types of price discrimination models which are used in economics. These models are the first, second, and the third degree of the price discrimination.
1st degree discrimination of price
First degree price discrimination (FDPD) also known as perfect price discrimination is the selling of each unit of its output for the maximum price obtainable; the maximum amount that buyers are willing to pay for that particular unit.
The diagram below depicts the situation when a monopoly is under 1st degree price discrimination.
The monopoly would sell the first unit of its output at a price slightly below F, the second unit at a slightly lower price, and so forth. The firm does not have to stop at output level Q** because it can sell the next unit at a price slightly below P**. The firm will continue to sell its output one unit at a time until it reaches output level Q* because sales would not be profitable when the output levels are greater than Q*; as the prices that buyers are willing to pay falls below marginal cost.
The result of FDPD leads to firms receiving total revenue of OFEQ*, incurring total costs of OP*EQ*, and, therefore obtaining total monopoly profits given by area P*FE. In this monopolist’s price discrimination strategy, all the consumers surplus available in the given market have been extracted into monopoly profits.
The price of additional output might be decreasing but might, however, represent extra income to the organization. This is due to the prices taken on “intra marginal sales” might remain not affected by extra sales at decreased prices (Stole, 2007, p.2221).
In most of the companies, which includes cars that are already used or the truck sales, there is usually an expectation to discuss and come up with the final purchase price, and this is known as part of the process of buying.
The method of data mining is used by the selling company to establish information and the trends concerning the buyer’s initial habits of purchasing products. It is a process which entails determining the budget, income and the maximum available output and therefore it helps in establishing how much can be charged for each car which is sold (Dana and Williams, 2018). However, this method of price strategy is somehow time-consuming and also tricky to put in place for most business. On the other hand, it has an advantage since it enables the seller to understand and set the maximum amount of the profit which is available for each of the sales made.
2nd Degree Discrimination of Price
Two part pricing implicitly involves discounts for purchases with large quantities. The implicit quantity discount would make two-part pricing profitable where the lower marginal price would leading consumers to consume more of that good, increasing consumer surplus and reducing deadweight loss. For example, if we take account of the $40 admission fee and the $1 price per ride involved in the profit maximising two-part strategy, a consumer who takes 10 rides would pay an average price of $5 per ride. By the 20 rides, the average price would fall to $3.
Quantity discount is common and can be see used by firms for many different goods including boxes of ready-to-eat cereal with large boxes selling for lower unit prices, and frequent-flyer programs with the airline giving away free travel of the passenger has travelled more than a threshold amount within the year.
The third degree of price discrimination
The third degree price discrimination (TDPD) also known as market-separating strategies is when consumers faces a single price rather than a tariff of prices. Potential customers are separated into two or more categories and charged different amounts in these markets. This practice may lead to an increase profits over what is obtainable under a single-price policy when the buyers are unable to shift their purchase from one market to another in response to price differences.
This can be depicted in the diagram below.
The figure is drawn so that the market demand and marginal revenue curves in the two markets share the same vertical axis, which records the price charged for the good in each market. The marginal cost is also assumed to be constant over all levels of output and the output levels obey the MR = MC rule for each market. The profit-maximizing level of output for the monopoly firm is at Q*1 in the first market and Q*2 in the second market; and the prices in the two markets are P1 and P2, respectively. It can be seen clearly from the figure that the market with less elastic demand curve has a higher price therefore the price-discriminating monopolist would charge a higher price in that market in which quantity purchased is less responsive to the changes in price.
This is a conventional type of price discrimination where firms attempt to divide the market into two appropriate segments or sections. If they vend the products in several countries, they may charge high amounts in few countries as compared to others (even in case of the same cost). They may provide specific terms for “seniors” or “students”. In the transport sector, they may charge varied prices for varied services at the day’s different times or attempt to segregate “business” from “leisure travellers” (Yoshida, 2000, p.240).
Maximisation requires that marginal revenue be the same in both markets and is equal to marginal cost c(y).
Discrimination of 3rd degree is associated directly to the ability and willingness of the consumer to recompense for the service or good. It shows that the amounts charged might bear no or little relation to the production cost (Yoshida, 2000, p.240). The market is usually divided into two methods: by geography or time. For instance, exporters might charge high prices in foreign markets in case demand is assessed to be highly inelastic as compared to it is in the markets of home country (Yoshida, 2000, p.240).
Comparison of first, second, and third degree of price discrimination
The comparison utilizes four significant factors, such as, information regarding consumers, market segmentation, social welfare, and profit maximization. This type of strategy of pricing occurs when businesses may accurately decide what all consumer wants to pay for particular service or product and selling that service or good for that price. The comparison demonstrate that whereas segmentation of market is the pre-requisite for 3rd-degree, it is a balanced outcome in 2nd-degree discrimination of price. The issue of profit maximization is unrestrained under 3rd-degree but this is controlled under 2nd-degree. Both consumer surplus and deadweight loss are constructive under 3rd-degree, but they both might be zero under 2nd-degree and increased social surplus.
(Figure 1: Price Equilibrium)
From the above graphs it can be stated that the change in price can shift the demand curve because it can be observed that the consumers usually prefer to buy the products which are cheaper in price. The graph in Figure 1 indicates that the change in price is causing a shift in the demand of a product. Moreover it can be stated that if there is a substitute to certain good whose price has been increased than the consumer will prefer the substitute to that certain product but if the good is complementary good than the increase in price will have a less impact on the demand.
Price Discrimination and Customer Profiling by Airlines
A distinct system of booking for air tickets called “New Distribution Capability (NDC)” takes information or data on the people’ profile in quest of airfares on comparison sites of the price before booking a ticket. The airlines provide more options for pricing to travelers, for instance, more full seats and in-flight movies. At the choice of the moment is typically restricted to the economy or business class. Individual book seats might have a choice to provide personal information to airlines, for instance, marital status, age, nationality, shopping history, travel history earlier purchased services, the frequent participation of flyer and whether the tour is envisioned for leisure or business (Odlyzko, 2003, p. 355). The airlines follow the 3rd degree price discrimination strategy, for instance, economy class for customers belong to middle class and business class for customers belong to upper class they set price according to the customers’ status
The “International Air Transport Association (IATA)” that signifies four hundred airlines which includes Lufthansa, British Airways, American Airlines, and Air-France-KL states it will permit airlines to reward and recognize consumers, and offer “Amazon-style” custom-made offers
Comprehensive profiling seems to provide the airlines with a broader scope for involving in discrimination of price by providing several variations in charges to passengers’ different groups for what is the identical product or journey (Odlyzko, 2003, p. 355). If the customer chooses a specific seat, meal, and different facilities, under the novel system, they must spend additional money (Armstrong and Vickers, 2001, p.579).
In top marketplace an organization will yield where “MR = MC and charge price Pa”, & in the “off-peak market,” an organization will yield where “MRb = MC” and charge rate Pb. Customers with an “inelastic demand” will recompense an increased price (Pa) as compared to those with the “elastic demand” from whom Pb will be charged (Gifford and Kudrle, 2009, p.1235).
Impact of the price set by a monopolist
The monopolist selects the prices to maximise the profit the prices set by the monopolist can increase and decrease the demand of a particular product within a particular area. The monopolies are regarded as a lack of the economical competitions to produce the desired goods and services as well as lack of feasible substitute goods. Therefore, as a result, it can be stated that a single producer of the goods and services has a control over the price of a certain good. In other words, it can be explained as the price maker can determine the level of price be the decision of the quantity of the good and services to be produced. It can be observed that the public utility organization usually tends to be monopolies. Having more than one provider of the goods and services can be inefficient. The production or the supply of the electricity can be considered, as an illustration, such as the price of the electricity is so high and the price of the electricity is fixed by the monopoly an there is no other substitute for the electricity and the consumer has no other option rather than paying for it (Gifford and Kudrle, 2009, p.1235).
Monopoly and Market Demand
The price of the monopolist can also affect the demand of the goods and services. It is stated that a monopoly has its market to itself as well as the demand curve indicates the impact of the monopoly on the demand. The perfect competition graph compares the demand situation a monopoly and a perfect competition by a firm (Grennan, 2013, p.145).
(Figure 2: Equilibrium price vs Demand)
From the first graph, it can be stated that the equilibrium price for a competitive firm can be determined and explained with the help of the intersection of the supply and demand curves. The supply curve represents the supply of certain goods and services of an individual firm. Also, the curves of the marginal cost lie above the average variable cost curves (Inderst, R. and Shaffer, 2009, p.658). The demand line in the panel (b) graph indicates that as it is the only one supplier in the market, therefore it has a hold on the price, which can impact the demand of the good. If there is no other substitute for a particular good then the consumer will pay the raised prices but if the consumers would have an option for the substitute than it might be possible that the demand of a certain good will be decreased and the consumer will start preferring the substitute good (Grennan, 2013, p.145).
Monopoly and elasticity
The elasticity of the demand concerning the price plays an important role in the implications and assessment of the impact of the price change by a monopoly on the total revenue. Also, it can be observed that the elasticity of the prices can be different as well as it may vary at different stages on the demand curve of an organisation (Aguirre et al. 2010, p.1601).
Aguirre, I., Cowan, S. and Vickers, J., 2010. Monopoly price discrimination and demand curvature. American Economic Review, 100(4), pp.1601-15.
Armstrong, M. and Vickers, J., 2001. Competitive price discrimination. rand Journal of economics, pp.579-605.
Gifford, D.J. and Kudrle, R.T., 2009. The law and economics of price discrimination in modern economies: time for reconciliation. UC Davis L. Rev., 43, p.1235.
Grennan, M., 2013. Price discrimination and bargaining: Empirical evidence from medical devices. American Economic Review, 103(1), pp.145-77.
Inderst, R. and Shaffer, G., 2009. Market power, price discrimination, and allocative efficiency in intermediate?goods markets. The RAND Journal of Economics, 40(4), pp.658-672.
Odlyzko, A., 2003, September. Privacy, economics, and price discrimination on the Internet. In Proceedings of the 5th international conference on Electronic commerce (pp. 355-366). ACM.
Stole, L.A., 2007. Price discrimination and competition. Handbook of industrial organization, 3, pp.2221-2299.
Yoshida, Y., 2000. Third-degree price discrimination in input markets: output and welfare. American Economic Review, 90(1), pp.240-246.