Price discrimination is the practice of charging different prices for the same product or service instead of selling it at a uniform price to all customers. Monopolistic businesses widely use price discrimination to maximize their sales. Price discrimination has following types:
The first degree price discrimination, in which the seller charges the maximum price a consumer is willing to pay. The second degree price discrimination, in which the seller charges higher price for the first unit and reduces price for each successive unit sold (commonly known as bulk discounts). The third degree price discrimination, in which the seller segregates customers into different classes by location, age etc. and charges different price to each class of consumers. A firm's pricing strategy may combine multiple types of price discrimination.
Price discrimination allows a seller to divide consumers on the basis of their price elasticity of demand. By charging higher price to consumers having low price elasticity of demand and lower price to consumer having higher price elasticity of demand, the seller achieves total sales higher than what could be achieved with uniform price for all customers.
Not all sellers have the ability to exercise price discrimination. The conditions required to use price discrimination are:
- The seller much have some degree of monopolistic powers to be able to control price and thus exercise price discrimination.
- The seller must have the ability to divide buyers into multiple classes at low cost on the basis of their price elasticity of demand.
- The seller must be able to stop resale of the product or service by the buyers. Businesses that exercise price discrimination usually employ licensing restrictions to prohibit buyers from reselling.
Examples of businesses practicing price discrimination are:
- Theatres, cinemas, zoos, gymnasiums and similar businesses when they charge consumers on the basis of age or time of the day or day of the week (usually lower prices at weekends).
- Retailers when they allow bulk discounts. Retailers may also practice other types of price discrimination such as charging higher price in "rich" areas and lower price in "poor" areas.
- Utility companies charging different rate per unit to commercial and non-commercial customers.
Sometimes, the practice of price discrimination may not be obvious. For example, when a retailer issues discount coupons redeemable at purchase, it is actually practicing price discrimination. In such circumstances, consumers whose price elasticity of demand is higher are more likely to avail the discount than those whose price elasticity of demand is low. Hence a portion of consumers pay lower price while the rest pay full price for an identical product or service. Lastly, we must be careful not to confuse product differentiation with price discrimination. The former involves selling different type of product at different prices.