Price Discrimination - Explained
What is Price Discrimination?
Written by Jason Gordon
Updated at July 8th, 2021
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Table of Contents
What is Price Discrimination?How does Price Discrimination Work? Market Segmentation for Price DiscriminationDifferent Types of Price DiscriminationAcademic Research on Price DiscriminationWhat is Price Discrimination?
Charging different prices for the same products or services to different customers based on certain attributes is called Price Discrimination. Pricing discrimination in the simplest terms is a pricing strategy that aims to charge customers the maximum price they can pay for a product or service.
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How does Price Discrimination Work?
Price discrimination is profitable in markets that allow limited flexibility, hence separation of the two market types - elastic and inelastic, is a desirable condition for the successful application of price discrimination. Customers are willing to pay more for a product in inelastic markets, while those in flexible markets can look for more affordable options.
Market Segmentation for Price Discrimination
Sellers segregate markets by customer type, income levels, public vs industrial products procurement, domestic vs. international, and other factors to implement Price Discrimination. For example, broadband services package prices may vary according to the state you are living in. Prices in New York would be much higher than prices in New Mexico. Software services packages are sold at standard rates to the general public, higher rates for enterprise usage, and lower rates for educational and non-profit organisations. Companies can enforce legal safeguards against consumers who buy in the lower price segments to make a profit in the higher priced segments.
Different Types of Price Discrimination
First Degree Price Discrimination - When firms charge the highest possible price per unit in a market segment. This is a rare occurrence and companies usually avoid the practice.
Second Degree Price Discrimination - Price discrimination based on quantity of units purchased. Bulk purchases incur lower costs while single unit purchases incur higher costs. AliBaba is a good example of a firm that charges more for single unit purchases while giving heavy discounts to bulk buyers.
Third Degree Price Discrimination - When firms charge different prices to different consumer groups based on factors like age, sex, citizenship status, and more. E.g., airline ticket prices for adults vs. reduced prices for children below 5. Higher venue ticket prices for tourists vs. lower prices for locals. This is the most commonly practiced type of Price Discrimination. Price Discrimination is a staple pricing strategy in airline ticket prices. Buyers who plan trips in advance pay lower prices for the same route than someone buying in emergency who ends up paying the highest price for the same route. Flights in demand automatically see a rise in prices while those with low number of passengers see a reduction in ticket costs. Holiday ticket prices are available at a premium while the same flights are available at lower prices for the rest of the year.
Academic Research on Price Discrimination
- Price discrimination and social welfare, Varian, H. R. (1985). Price discrimination and social welfare. The American Economic Review, 75(4), 870-875. This paper studies the correlation between price discrimination and social welfare.
- Intertemporal price discrimination, Stokey, N. L. (1979). Intertemporal price discrimination. The Quarterly Journal of Economics, 355-371. This journal discusses the practice of price discrimination under different market conditions at various points in time.
- Price discrimination by US and German exporters, Knetter, M. M. (1989). Price discrimination by US and German exporters. The American Economic Review, 79(1), 198-210. This study analyses Price Discrimination practices by exporters in Germany and USA for different raw materials and products.
- Network competition: II. Price discrimination, Laffont, J. J., Rey, P., & Tirole, J. (1998). Network competition: II. Price discrimination. The RAND Journal of Economics, 38-56. This paper studies the effect of Price Discrimination in the field of telecommunication networks.
- Competitive price discrimination, Armstrong, M., & Vickers, J. (2001). Competitive price discrimination. rand Journal of economics, 579-605. This journal studies factors influencing competitive Price Discrimination and its outcomes with different variables.
- A price discrimination theory of coupons, Narasimhan, C. (1984). A price discrimination theory of coupons. Marketing Science, 3(2), 128-147. This paper studies the theory of Price Discrimination with the help of data from coupon usage practices.
- Output and welfare implications of monopolistic third-degree price discrimination, Schmalensee, R. (1981). Output and welfare implications of monopolistic third-degree price discrimination. The American Economic Review, 71(1), 242-247. This review sheds light on the practice of Third degree Price Discrimination and its implication on welfare and production.
- Spatial price discrimination, Hoover, E. M. (1937). Spatial price discrimination. The Review of Economic Studies, 4(3), 182-191. This review explores the effect of competitive Price Discrimination under monopolistic conditions.
- Price discrimination and competition, Stole, L. A. (2007). Price discrimination and competition. Handbook of industrial organization, 3, 2221-2299. This chapter looks at the advancements in Price Discrimination theory as its applied in competitive market under imperfect conditions.
- The noisy monopolist: Imperfect information, price dispersion and price discrimination, Salop, S. (1977). The noisy monopolist: Imperfect information, price dispersion and price discrimination. The Review of Economic Studies, 44(3), 393-406. This review studies the correlation between heterogeneous market forces like imperfect information and more, that influence Price Discrimination.
- The effects of third-degree price discrimination in oligopoly, Holmes, T. J. (1989). The effects of third-degree price discrimination in oligopoly. The American Economic Review, 79(1), 244-250. This paper studies the effect of Third degree Price Discrimination practices in an Oligopoly.
- Price discrimination in free-entry markets, Borenstein, S. (1985). Price discrimination in free-entry markets. The RAND Journal of Economics, 380-397. This paper analyses the implications of Price Discrimination in free-entry markets.
- International price discrimination in the European car market, Verboven, F. (1996). International price discrimination in the European car market. The RAND Journal of Economics, 240-268. This paper analyses data from the European car market to study the effect of International Price Discrimination.
- Privacy, economics, and price discrimination on the Internet, 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. This paper tries to answer the questions raised by the economy of internet, importance of privacy, and the implications on Price Discrimination.