Price discrimination is a practice whereby a firm sells its product or service at different prices to different consumers.
The primary condition for price discrimination is that price elasticity of demand (PED) among customers have to be different. Price discrimination would not be possible if all buyers have the same demand curve.
The second condition for PD is no possibility of resale. If resale of the product or service is possible, then a customer can buy at a lower price and resell it in areas where the higher price is being charged. This practice will cause the higher price to eventually fall.
Given the market characteristics, the downward sloping curve must consequently, the monopolists has the power to be a price-maker.
When market conditions permit, a monopolist might choose to price discriminate. This entails charging different prices to different group of consumers for the same product or services. Monopolist would aim to charge prices and quantity that maximizes profit.
Price discrimination happens when a firm charges a different price to different group of consumers for an identical goods or services, for reasons that are not associated with costs of supply. For monopoly, the price that they charge depends on the good that is being sold and how easy it is to identify and segment members of the two or more groups.
First degree price discrimination occurs when the producer charges each individual consumers the highest price they are prepared to pay. With the conditions for price discrimination met, this implies that the monopolist have a great deal of knowledge about the willingness of consumers to pay. Consequently the producer captures the entire consumer surplus, which then becomes extra producer revenue.
A monopolist can appropriate ABEG of consumer surplus by price discriminating selling OK output to those consumers prepared to pay a minimum OB, and selling KH to other consumers only prepared to pay a minimum of OA.
The demand curve for price discrimination would be the marginal revenue curve as in such an auction the price does not have to be lowered to ell additional units of the product.
– It is difficult to find examples of this type of price discrimination although the internet auction website eg. eBay has some similarities. A seller on eBay will capture the entire consumer surplus of the successful bidder if the auction is highly contested. For example, if a seller has five rare identical goods for sale on eBay and the auction is highly contested with ten bidders then it is possible that the seller captures the entire consumer surplus of the five successful bidders. With this type of price discrimination the demand curve is actually the marginal revenue curve as in such an auction the price does not have to be lowered to sell additional units of the product.
Second degree price discrimination, or non linear pricing, involves setting tariff prices subject to the amount bought, in an attempt to capture part of consumer surplus.
When a firm has surplus capacity it is possible that some potential consumers will be targeted by a lower price. These consumers would not normally buy the product at the standard price but a special lower price will attract them. This type of pricing is particularly popular when there is spare capacity and the special price (marginal revenue) is higher than the marginal cost.
For example, a hotel can fill an extra room at the same marginal cost until they reach capacity, Qm. A profit maximizing hotel firm will produce MC=MR, pricing at P1 with quantity Q1. The problem with remaining at this production point is that excess rooms will be until led, the distance from Q1 to Qm. There are large fixed costs for the hotel to pay, which the hotel can contribute towards as long as these rooms are sold at a greater price than marginal costs at P2. For example, citing last minute deals becoming available. This way the hotel is contributing towards its fixed costs or adding to its profit with these consumers benefiting from extra consumer surplus of ABC due to purchasing these hotel rooms via a last minute deal.