Price Discrimination Definition Types Examples Degrees

Price Discrimination Definition

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Price Discrimination (wallstreetmojo.com)

The price discrimination strategy is mostly found effective in a monopolistic market, where sellers are free to determine the prices without obeying any standard pricing mechanisms, rules, or laws. It is different from product differentiation as the distinction is made between the products and not their prices.

Key Takeaways

Price discrimination refers to the charging different prices for the same products in different markets. The pricing mechanism depends on the company’s monopoly, preferences of the customers, uniqueness of the product, and the willingness of the people to pay differently.First degree, second degree, and third degree are the types of cost discrimination.Imperfect competition, resale prevention, the elasticity of demand, market segregation, etc., are some conditions that companies need to meet to adopt such strategies.

How Does Price Discrimination Work?

Price discrimination occurs when sellers decide to make more profit by determining a reasonable price, which consumers are willing to pay. This is a strategy adopted to ensure boosting the sales figures. The prices can either be more or less, given the ability of the consumers to pay and their consumption habits and situations.

When competition is high, every business in the market tries to leave its competitor behind. As a result, they keep the pricing as lenient as possible. In the process, the sellers divide customers into different segments depending on their demographics and preferences. Furthermore, they fix separate prices to be paid for a product or service purchased by those groups.

The strategy works effectively only when the company enjoys a monopoly in the market. Secondly, the customers’ interests and preferences matter and how unique a product to be sold is. Finally, when the brands shift the prices of the products in the different markets under monopoly price discrimination, it maximizes profits for businesses, thereby reducing costs for most customers in most cases.

Types of Price Discrimination

Price discrimination occurs in various forms, including first degree, second degree, and third degree.

First degree price discrimination, also referred to as perfect price discrimination, is the strategy whereby firms fix the maximum price for each unit of product and service. As the ability of consumers to bear the cost of products is hard to determine, companies refrain from adopting this strategy. Consumer surplus is nowhere in this type of cost discrimination.Second degree price discrimination refers to the price set per the quantity consumed. It is also known as product versioning or menu pricing. It may also involve creating a different product lineProduct LineProduct Line refers to the collection of related products that are marketed under a single brand, which may be the flagship brand for the concerned company. Typically, companies extend their product offerings by adding new variants to the existing products with the expectation that the existing consumers will buy products from the brands that they are already purchasing.read more similar to a menu card in which more options are given for the same product with minor changes to sell them at a differential price. For example, a mobile data recharge plan is priced differently from the amount of data used.Third degree discrimination, also termed group pricing, occurs when firms divide their consumers into different groups and sell the same products at different prices to specific groups. For example, infants can enjoy a flight free of cost, while anyone above two has to pay for the flight tickets.

Conditions

Though price discrimination is one of the most effective strategies for boosting sales, not all companies have the liberty to implement it. There are certain criteria or requirements that a firm needs to fulfill to adopt any such strategy. Some of the conditions include:

#1 – Firm’s Monopoly

When the firm has a monopoly in the market, it becomes the price makerPrice MakerPrice maker (P-M) refers to a firm having enough market power to control the market prices of its products and services without losing its customers.read more. An imperfect marketImperfect MarketImperfect market structure is a part of microeconomics in which companies sell different products and services, as opposed to perfect competitive markets in which homogeneous products are sold. Companies in this sector have some pricing power with high barriers to entry, resulting in higher profit margins as each company tries to differentiate their products and services through innovative technology.read more gives companies the liberty to opt for such cost strategies.

#2 – Market Segmentation

Segmenting markets to make this pricing strategy work is a must. Thus, companies need to divide the markets based on various factors, including age, gender, preferences, physical distance, nature of the product, time, etc. Based on this division, companies can implement dynamic pricingDynamic PricingDynamic pricing is a pricing strategy that ignores fixed pricing and instead uses variable pricing, or in other words, it is a strategy in which the price of a specific product changes in response to ongoing customer demand and supply.read more strategies based on the time of sale or the demand for a product.

The market segments should be divided such that no two markets get entangled at any cost. The seepage of one market into the other would mean resale facilitation. As a result, the entities that purchase the goods and resell them at a lower rate would start getting direct customers, making the original sellers incur huge losses. Thus, it is important to prevent resale opportunities.

#3 – Elasticity of Demand

Furthermore, the elasticity of demand plays a great role in determining if price discrimination would work for a company. For example, a lower income group searches for options that involve less expenditure, and hence, they narrow down their options being elastic. On the other hand, the higher income groups are ready to spend more, and therefore they are open to wider options and have more demands.

This elasticity level of the lower income group might restrict the effectiveness of such a pricing strategy, while the inelasticity of demand among higher income groups could make it work.

Examples

Let us consider the following price discrimination examples to understand how the strategy works:

Example #1

In the case of weddings, the seller of the goods and services may charge a slightly higher price than its usual charges, taking advantage of the event to earn more.

Example #2

The wholesalers of the goods and services may charge a differential pricing strategy to the retailers who buy in bulk compared to those who buy in small quantities. For example, they might offer hefty discounts for bulk purchases.

Example #3

In the case of a flat, the per-square-feet rate for one area may be very expensive due to the location accessibility, and facilities, while the same flat may have a lower price if located in another area.

For example, 400 square feet flat in New York might cost $5,00,000 since New York is the financial capital of the United States of America, while the same 400 square feet flat might cost only $300,000 in New Jersey, the city being comparatively less expensive to live in. The price discrimination, here, is based on the location, connectivity, facilities, etc.

Advantages & Disadvantages

Though price discrimination seems to support a market in a positive way, some cons might restrict businesses from adopting this strategy. So, let us have a look at the advantages and disadvantages of the concept in a tabular form below: