Price Discrimination
What Is Price Discrimination?
Price discrimination is a microeconomic pricing strategy where a provider sells identical or nearly identical goods or services at different prices to different market segments (Fouad Sabry et al., 2023). Also known as one-to-one marketing, this practice aims to match the price to a customer's reservation price or willingness to pay (Rakesh V. Vohra et al., 2012). By charging different prices based on differences in demand, firms can capture consumer surplus and increase overall revenue compared to a uniform pricing strategy (Luke Froeb et al., 2017).
Primary Components and Degrees of Price Discrimination
Economists categorize price discrimination into three degrees. First-degree, or personalized pricing, involves charging each customer a unique price (Fouad Sabry et al., 2023). Second-degree, or menu pricing, encourages consumers to self-select through different product packages or quality versions (Paul Belleflamme et al., 2015). Third-degree, or group pricing, segments the market using observable signals like age, occupation, or time of purchase to charge different prices to specific groups, such as students or seniors (Rakesh V. Vohra et al., 2020).
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Functional Application and Necessary Conditions
For price discrimination to function, a firm must possess market power, typically within monopoly or oligopoly structures (Fouad Sabry et al., 2023). The seller must solve the identification problem by distinguishing between consumer types and the arbitrage problem by preventing low-price buyers from reselling to high-price buyers (Lynne Pepall et al., 2011). If arbitrage is possible, it can defeat the pricing scheme and force a return to uniform pricing (Luke Froeb et al., 2017). Resale prevention is often easier in services than in physical goods (Fouad Sabry et al., 2023).
Illustrative Examples and Market Implications
Real-world examples include student discounts at museums, peak-load pricing for utilities, and intertemporal discrimination in movie releases (Fouad Sabry et al., 2023)(Edgar K. Browning et al., 2019). While it can increase firm profits, price discrimination may also raise social welfare by increasing total output (Lynne Pepall et al., 2011). However, it can trigger consumer outrage if discovered, as shoppers often feel it is unfair to pay more than others for the same product (Luke Froeb et al., 2017)(Ariel Ezrachi et al., 2016).
