Price discrimination is a pricing strategy where one business charges consumers different prices for identical goods and services in different markets. In essence, businesses use price discrimination to ensure they maximize the revenue that is made from each customer. Price discrimination is a pricing strategy where identical or near-identical products and services are sold at different prices in different markets by the same supplier.
Understanding price discrimination
The price of movie tickets is one example of price discrimination at work, with separate prices for children, adults, families, and seniors.
Movie ticket prices also vary according to the time of day and whether the movie is a blockbuster new release or a timeless old classic.
Three types of price discrimination
There are three general types of price discrimination, with each consisting of various pricing strategies businesses use.
An explanation of each of these is provided below.
First degree price discrimination is also known as perfect price discrimination and this perfection makes it difficult to implement in practice.
Nevertheless, it involves the business charging the maximum price consumers are willing to pay for each unit of product or service sold.
This allows the business to capture all the consumer surplus in the market, which can be defined as the difference in price between what the consumer actually pays and what they are prepared to pay.
Second degree price discrimination is perhaps the most recognizable and involves the business charging a different amount according to the amount or quantity consumed.
Frequent flyer programs, for example, reward customers with cheaper tickets the more they fly with an airline. Phone and internet data also tends to be cheaper the more data that is consumed.
Second-degree price discrimination is sometimes referred to as indirect price discrimination since companies allow consumers to choose what price they will ultimately pay.
Some choices which appear more cost-effective on the surface are only affordable because the business imposes an extra cost on the consumer.
This includes pricing that is influenced by coupon collecting and bulk purchases, among other factors.
Third degree price discrimination is the strategy that movie theatres employ where different prices are charged to different groups of people such as:
- Emergency services personnel.
- Men or women.
This form of price discrimination is also often used by utility, parking lot, and gym businesses to charge one price for peak usage and another for off-peak usage.
What are the necessary conditions for effective price discrimination?
For price discrimination to be effective, a few conditions must be met:
The company must be a price maker
That is, it must operate in an imperfect market with a demand curve that slopes downwards.
The company should also possess some degree of monopoly power.
The ability to separate markets
The company must also be able to prevent the resale of its products and services to consumers who would otherwise have to pay a higher price.
A children’s movie ticket, for instance, would need to be distinguishable from an adult’s ticket.
Microsoft Office for university students must also be kept separate from home or workplace users.
Online, eCommerce companies use dynamic pricing where prices vary from second to second according to real-time demand and other metrics.
Elasticity of demand
There must also be different elasticities of demand within the same market for price discrimination to be effective.
This means the airline can sell cheaper “red-eye” flights or those without meals to target this segment.
Airlines commonly use price discrimination strategies. They offer different prices for the same flight based on factors like booking time, day of the week, and flexibility of the ticket. Business travelers who need to book flights at the last minute might pay higher prices, while leisure travelers who book in advance may find lower fares.
Software companies often implement price discrimination by offering different licensing options based on usage. They might offer lower prices for individual users, higher prices for businesses with multiple users, and even higher prices for enterprise-level features and support.
Streaming platforms like Netflix and Spotify use price discrimination by offering tiered subscription plans. Customers can choose between basic, standard, and premium plans, each with varying features and pricing. This allows the service to cater to different segments of users with different needs and budgets.
Hotels employ price discrimination by offering different rates for rooms based on factors such as room size, amenities, and booking timing. Guests booking a standard room in advance might pay a lower rate, while those who opt for suites or book closer to the check-in date might pay higher prices.
Educational institutions often use price discrimination with tuition fees. They might charge different rates for in-state and out-of-state students, as well as different rates for undergraduate and graduate programs. Scholarships and financial aid can also be considered a form of price discrimination to attract students of varying financial backgrounds.
Cell Phone Plans
Cell phone companies apply price discrimination through their various plan offerings. They offer different plans with varying data limits, talk minutes, and text messages. Customers can choose plans that align with their usage needs, allowing the company to cater to different customer segments.
Concert promoters use price discrimination by offering different ticket prices based on seating locations. Front-row seats or VIP sections are often priced higher, while seats farther from the stage are offered at lower prices. This allows fans to choose the experience and price point that suits them.
Fast Food Combos
Fast food chains often create combo meals that bundle a burger, fries, and a drink at a slightly discounted price compared to purchasing each item separately. This encourages customers to spend more by providing perceived value while boosting overall sales for the restaurant.
Online retailers frequently use price discrimination by offering discounts and promotions to specific customer segments. They might provide exclusive discounts to newsletter subscribers, first-time customers, or those who have abandoned their shopping carts, encouraging them to complete their purchases.
Gyms and fitness centers use price discrimination by offering different membership packages. They may have basic memberships with access to standard equipment and premium memberships with additional perks like personal training sessions or exclusive classes. This allows them to target customers with varying fitness goals and budgets.
- Price discrimination is a pricing strategy where identical or near-identical products and services are sold at different prices in different markets by the same supplier.
- There are three types of price discrimination: first degree, second degree, and third degree. Each type has a selection of unique price discrimination strategies.
- To be effective, price discrimination must be carried out by a company operating in an imperfect market with the ability to segment its products. There must also be varying elasticity of demand within the market itself.
- Definition of Price Discrimination:
- Examples of Price Discrimination:
- Movie tickets: Different prices for children, adults, families, and seniors.
- Time-based pricing: Varying movie ticket prices based on time of day and movie popularity.
- Types of Price Discrimination:
- First Degree Price Discrimination:
- Also known as perfect price discrimination.
- Charging each customer the maximum price they’re willing to pay.
- Capturing all consumer surplus in the market.
- Difficult to implement due to the need to know individual willingness to pay.
- Second Degree Price Discrimination:
- Charging different prices based on the quantity consumed.
- Examples include bulk discounts, frequent flyer programs, data plans.
- Consumers choose the price by selecting a consumption level.
- Often referred to as indirect price discrimination.
- Third Degree Price Discrimination:
- First Degree Price Discrimination:
- Conditions for Effective Price Discrimination:
- Price Maker: Operates in an imperfect market with demand curve sloping downwards.
- Ability to Segment Markets: Prevents resale of products between segments.
- Elasticity of Demand: Different elasticities within the market; some customers more sensitive to price changes than others.
- Benefits and Takeaways:
- Price discrimination allows businesses to capture different consumer segments and maximize revenue.
- It requires understanding market conditions, customer behaviors, and demand elasticity.
- Implementing price discrimination strategies can enhance profitability in competitive markets.
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