Price discrimination

Price discrimination exists when sales of identical goods are transacted at different prices from a single vendor. Theoretically, price discrimination is a feature only of monopoly markets. In addition to a monopoly market, price discrimination requires some means to discourage discount customers from becoming resellers and by extension competitors.

It can be proved mathematically, that a firm facing a downward sloping demand curve that is convex to the origin will always obtain higher revenues under price discrimination than under a single price strategy.

There are three types of price descrimination:

• In first degree price discrimination, price varies by customer. This arises from the fact that the value of goods is subjective. A customer with low price elasticity will be prepared to pay more than a customer with high price elasticity of demand.

• In second degree price discrimination, price varies according to quantity sold. Larger quantities are available at a lower unit price.

• In third degree price discrimination, price varies by location. See economics of location.

In economic terms,the purpose of price discrimination is to capture the market's consumer surplus. This surplus arises because, in a market with a single clearing price, some customers (the very low price elasticity segment) would have been prepared to pay more than the single market price. Price discrimination transfers some of this surplus from the consumer to the producer/marketer.

Price skimming is a type of price discrimination. It is price discrimination over time. Typically a company starts selling a new product at a relatively high price then gradually reduces the price as the low price elasticity segment gets satiated.

A closely related concept is yield management. In price discrimination firms charge different prices depending on who buys the product, who buys what quantities, and who buys in what locations. In some jurisdictions this is illegal. In yield management, firms charge different prices depending on minor variations in the product. These firms typically engage in product differentiation. They modify their product offerings so that each product is optimized for a particular target market. Hense charging a business traveller three times the cost of an economy airplane seat is not price discimination. It is yield management because the product is different (larger seats, and better food than economy class).

see also: pricing, marketing, microeconomics, price