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Price discrimination occurs when firms sell the same good to different groups of consumers at different prices. There are often different types of price discrimination offered. Often they are categorised in the following way:

• 1st degree price discrimination – charging the maximum price consumers are willing to pay.
• 2nd degree price discrimination – charging different prices depending on the quantity consumed.
• 3rd degree price discrimination – charging different prices depending on a particular market segment, e.g. age profile, income group, time of use.
• 4th degree price discrimination – when prices to consumers are same, but the producer faces different costs. Also known as reverse price discrimination.
• Premium pricing. In many examples of ‘price discrimination’ consumers are charged different prices for a similar goods. In these examples, consumers pay a premium for a slightly more expensive option. For example, ‘premium unleaded petrol’ may cost the firm an extra 1p over standard unleaded, but the firm may sell this premium unleaded at 5p. This is not true price discrimination, but uses the same principles – finding customers with more inelastic demand. It’s use is widespread, such as first and standard class.

Examples of Price discrimination:

1. Time of Purchase

This petrol station is offering cut price fuel for two days a week. The petrol station isn’t even telling you which days have cut price fuel. The logic is that only the most price sensitive consumers will take the trouble to find out which two days have cut price fuel and then drive to the petrol station on those days. This takes planning and only the most price elastic consumers will buy on these cut price days. Most consumers will not take the trouble to visit the petrol station on those two days. They will continue to buy when most convenient.

It is also a clever marketing strategy because from a distance, it is advertising ‘cut price fuel’ you only notice the ’2 days a week’ on closer inspection. This is a type of third degree price discrimination.

2. Airline travel and time of departure

Airlines charge different prices depending on the season and day of the week. During the peak holiday season in August and Easter, the price will be higher because demand is greater and more inelastic. Flights which occur during the week e.g. Mon to Fri, will be more expensive because these are typically taken by business travellers. If you stay for over the weekend, the price will be lower, as business travellers will not want to stay over the weekend, just to get a cheaper flight. I often go to New York for a week in October. For a flight from Mon to Fri, the price quoted is usually around £1,500. If I change dates to leaving or arriving on the weekend, the price falls to £450.

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Readers Question: Is it better to sell more services/products with less profit, than sell less with high profits? What are the pros and cons to the employer, worker, and customer? i.e high revenue low profit, vs low revenue high profit.

Classical economic theory suggests firms will seek to maximise profits. The benefits of maximising profit include:

• Profit can be used to pay higher wages to owners and workers. (though if firm has monopsony power, the profit may not be shared equally amongst workers)
• Profit can be used to invest in research & development. This investment can potentially benefit consumer. For example, without large profits, drug companies would have less ability to develop new drugs. High profit is often a justification for pharmaceuticals to have a degree of monopoly power (e.g. patents) because ultimately it is essential for creating the incentive to develop new treatments. However, this argument about research & development may depend on the industry. For example, it is now clear how much supernormal profit supermarkets need to be able to invest in research & development.
• Profit enables the firm to build up savings, which could help the firm survive an economic downturn. For example, in a recession, a firm could see a temporary loss, but if the firm has a reasonable level of savings and history of profitability, the bank will be more willing to keep lending. However, profitable firms don’t necessarily save this profit for an economic downturn. Profit is often paid to shareholders in the form of dividends or used to finance expansion, such as mergers or takeovers. For example, commercial banks were very profitable in the boom years, leading upto 2007. But, when the credit crunch hit, they had very little resources to ride out the financial crisis.
• For firms listed on the stockmarket, high levels of profit will make the firm less susceptible to takeoevers. If profit is low, sharedholders may be dissappointed in the low level of dividends and willing to sell to a takeover bid. You could argue this incentive to be profitable is good for consumers because the firm has incentives to be efficient and cut costs, which can lead to lower prices for consumers. However, you could argue, that the pursuit of short-term profit has drawbacks because the firm may not invest sufficiently in the long-term development of products and services. For example, train operating companies listed on stock market may go for short-term profit, and ignore long-term investment for industry.

Benefits of Pursuing Revenue Maximisation

Some firms don’t make profit maximisation as their ultimate goal. They seek to maximise revenue or market share. Seeking to increase market share and sales will lead to lower profit, but can have advantages for firms, consumers and workers.

• Increased brand loyalty. If a firms is able to cut prices and gain more customers, it will gain bigger exposure and brand loyalty. This enables the firm to be more prominent in the market. For example, in supermarkets, price is very important and getting a reputation of being cheapest supermarket can help attract customers. Continue Reading →