Price Discrimination
What is Price Discrimination?
Price discrimination is the practice of charging different prices to different consumers for the same product based on their willingness to pay.
To engage in price discrimination, a firm must have market power, be able to identify different consumer groups, and prevent resale between groups. It increases profits by capturing more consumer surplus.
Price Discrimination: a worked example
A campus cinema has 300 seats, and one more viewer costs it nothing. Charging a single price of $12 it sells 200 tickets, so revenue is 12 x 200 = $2,400. It then starts checking student ID: students pay $8, everyone else pays $15. At those prices it sells 180 student tickets and 80 other tickets, so revenue is (8 x 180) + (15 x 80) = 1,440 + 1,200 = $2,640. Revenue rose by $240 and 60 more people saw the film, because the cinema no longer had to pick one price that either priced students out or left the willingness to pay of everyone else untouched.
The mistake students make with price discrimination
Students conclude that price discrimination must shrink output and destroy efficiency, since it comes from market power. A perfectly price-discriminating firm actually produces the allocatively efficient quantity, the same amount a competitive market would, because it keeps selling to anyone who values a unit at more than marginal cost. Deadweight loss falls to zero. What disappears is consumer surplus, which turns into producer surplus. The mistake is treating bad for buyers and bad for efficiency as the same claim.
Price Discrimination questions
What is the difference between first, second and third degree price discrimination?
First degree price discrimination charges every buyer the exact maximum they would pay, capturing all consumer surplus. Second degree charges by quantity or version, such as a bulk discount or a cheaper stripped-down model, and lets buyers sort themselves. Third degree charges different prices to identifiable groups such as students or seniors. Third degree shows up most in textbook problems because ID makes the groups easy to separate.
Does price discrimination cause deadweight loss?
Perfect price discrimination eliminates deadweight loss rather than causing it. Because the firm charges each buyer their own maximum, it has no reason to hold back units, so it produces every unit worth at least its marginal cost. Output matches the competitive quantity and the triangle of lost gains vanishes. Third degree discrimination only shrinks part of that triangle, since each group still faces a single price above marginal cost.
Why can't buyers just resell to defeat price discrimination?
Resale would defeat price discrimination, which is exactly why firms design around it. A cheap ticket that only works with matching student ID, a haircut, a plane seat printed with a name, or software tied to one account all resist transfer. When resale is easy, low-price buyers become middlemen who undercut the high price, the two groups collapse into one market, and the pricing scheme falls apart.
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