PRICE DISCRIMINATION

-By Prof.Neha

PRICE DISCRIMINATION OR PRICE DIFFERENTIATION

Price discrimination or price differentiation exists when sales of identical goods or services are transacted at different prices from the same provider. In a theoretical market with perfect information, perfect substitutes, and no transaction costs or prohibition on secondary exchange (or re-selling) to prevent arbitrage, price discrimination can only be a feature of monopolistic and oligopolistic markets, where market power can be exercised. Otherwise, the moment the seller tries to sell the same good at different prices, the buyer at the lower price can arbitrage by selling to the consumer buying at the higher price but with a tiny discount

PRICE DISCRIMINATION OR PRICE DIFFERENTIATION

However, product heterogeneity, market frictions or high fixed costs (which make marginal-cost pricing unsustainable in the long run) can allow for some degree of differential pricing to different consumers, even in fully competitive retail or industrial markets. Price discrimination also occurs when the same price is charged to customers which have different supply costs.

RATE FENCE

The boundary set up by the marketer to keep segments separate are referred to as rate fence. Price discrimination is thus very common in services, where resale is not possible; an example is student discounts at museums. Price discrimination in intellectual property is also enforced by law and by technology. In the market for DVDs, DVD players are designed - by law - with chips to prevent use of an inexpensive copy of the DVD (for example legally purchased in India) from being used in a higher price market (like the US). The Digital Millennium Copyright Act has provisions to outlaw circumventing of such devices to protect the enhanced monopoly profits that copyright holders can obtain from price discrimination against higher price market segments.

EFFECTS

The effects of price discrimination on social efficiency are unclear; typically such behaviour leads to lower prices for some consumers and higher prices for others. Output can be expanded when price discrimination is very efficient, but output can also decline when discrimination is more effective at extracting surplus from highvalued users than expanding sales to low valued users. Even if output remains constant, price discrimination can reduce efficiency by misallocating output among consumers. Price discrimination requires market segmentation and some means to discourage discount customers from becoming resellers and, by extension, competitors. This usually entails using one or more means of preventing any resale, keeping the different price groups separate, making price comparisons difficult, or restricting pricing information. Price discrimination can also be seen where the requirement that goods be identical is relaxed. For example, so-called "premium products" (including relatively simple products, such as cappuccino compared to regular coffee) have a price differential that is not explained by the cost of production. Some economists have argued that this is a form of price discrimination exercised by providing a means for consumers to reveal their willingness to pay.

TYPES OF PRICE DISCRIMINATION

First degree price discrimination

price varies by customer's willingness or ability to pay. This arises from the fact that the value of goods is subjective price varies according to quantity sold. Larger quantities are available at a lower unit price. This is particularly widespread in sales to industrial customers, where bulk buyers enjoy higher discounts. price varies by attributes such as location or by customer segment, or in the most extreme case, by the individual customer's identity; where the attribute in question is used as a proxy for ability/willingness to pay.

Second degree price discrimination

Third degree price discrimination

PRICE SKIMMING

In price skimming, price varies over time. Typically a company starts selling a new product at a relatively high price then gradually reduces the price as the low price elasticity segment gets satiated.

COMBINATION
These types are not mutually exclusive. Thus a company may vary pricing by location, but then offer bulk discounts as well. Airlines use several different types of price discrimination, including: Bulk discounts to wholesalers, consolidators, and tour operators Incentive discounts for higher sales volumes to travel agents and corporate buyers Seasonal discounts, incentive discounts, and even general prices that vary by location. Discounted tickets requiring advance purchase and/or Saturday stays. Both restrictions have the effect of excluding business travellers, who typically travel during the workweek and arrange trips on shorter notice. First degree price discrimination based on customer. It is not accidental that hotel or car rental firms may quote higher prices to their loyalty program's top tier members than to the general public

MODERN TAXONOMY
The first/second/third degree taxonomy of price discrimination is: Complete discrimination -- where each user purchases up to the point where the user's marginal benefit equals the marginal cost of the item; Direct segmentation -- where the seller can condition price on some attribute (like age or gender) that directly segments the buyers; Indirect segmentation -- where the seller relies on some proxy (e.g., package size, usage quantity, coupon) to structure a choice that indirectly segments the buyers.

HIERARCHY
The hierarchycomplete/direct/indirectis in decreasing order of
profitability and information requirement.

Complete price discrimination is most profitable, and requires the seller to have the most information about buyers. Indirect segmentation is least profitable, and requires the seller to have the least information about buyers.

Sales revenue without and with Price Discrimination

EXPLANATION

The purpose of price discrimination is generally to capture the market's consumer surplus. This surplus arises because, in a market with a single clearing price, some customers (the very low price elasticity segment) would have been prepared to pay more than the single market price. Price discrimination transfers some of this surplus from the consumer to the producer/marketer. Strictly, a consumer surplus need not exist, for example where some below-cost selling is beneficial due to fixed costs or economies of scale. An example is a high-speed internet connection shared by two consumers in a single building; if one is willing to pay less than half the cost, and the other willing to make up the rest but not to pay the entire cost, then price discrimination is necessary for the purchase to take place.

EXPLANATION OF DIAGRAM

It can be proved mathematically that a firm facing a downward sloping demand curve that is convex to the origin will always obtain higher revenues under price discrimination than under a single price strategy. In the top diagram, a single price (P) is available to all customers. The amount of revenue is represented by area P, A,Q, O. The consumer surplus is the area above line segment P, A but below the demand curve (D). With price discrimination, (the bottom diagram), the demand curve is divided into two segments (D1 and D2). A higher price (P1) is charged to the low elasticity segment, and a lower price (P2) is charged to the high elasticity segment. The total revenue from the first segment is equal to the area P1,B, Q1,O. The total revenue from the second segment is equal to the area E, C,Q2,Q1. The sum of these areas will always be greater than the area without discrimination assuming the demand curve resembles a rectangular hyperbola with unitary elasticity. The more prices that are introduced, the greater the sum of the revenue areas, and the more of the consumer surplus is captured by the producer. Note that the above requires both first and second degree price discrimination: the right segment corresponds partly to different people than the left segment, partly to the same people, willing to buy more if the product is cheaper. It is very useful for the price discriminator to determine the optimum prices in each market segment. This is done in the next diagram where each segment is considered as a separate market with its own demand curve. As usual, the profit maximizing output (Qt) is determined by the intersection of the marginal cost curve (MC) with the marginal revenue curve for the total market (MRt).

Multiple Market Price Determination

The firm decides what amount of the total output to sell in each market by looking at the intersection of marginal cost with marginal revenue (profit maximization). This output is then divided between the two markets, at the equilibrium marginal revenue level. Therefore, the optimum outputs are Qa and Qb. From the demand curve in each market we can determine the profit maximizing prices of Pa and Pb. It is also important to note that the marginal revenue in both markets at the optimal output levels must be equal, otherwise the firm could profit from transferring output over to whichever market is offering higher marginal revenue. Given that Market 1 has a price elasticity of demand of E1 and Market of E2, the optimal pricing ration in Market 1 versus Market 2 is P1 / P2 = [1 1 / E2] / [1 1 / E1]

EXAMPLES OF PRICE DISCRIMINATION

Retail price discrimination Travel industry Coupons Premium pricing Segmentation by age group and student status Discounts for members of certain occupations Employee discounts Retail incentives Incentives for industrial buyers Gender-based examples "Ladies' night" Dry cleaning Haircutting Financial aid in education Haggling International price discrimination Academic pricing Dual pricing Wage discrimination

UNIVERSAL PRICING

Universal pricing is the opposite of price discrimination one price is offered for the good or service. This is usually preferred by consumers over tiered pricing. For example, the European Union is currently making efforts to set a single-price protocol for automobile sales.

TWO NECESSARY CONDITIONS FOR PRICE DISCRIMINATION

There are two conditions that must be met if a price discrimination scheme is to work. First the firm must be able to identify market segments by their price elasticity of demand and second the firms must be able to enforce the scheme. For example, airlines routinely engage in price discrimination by charging high prices for customers with relatively inelastic demand business travellers - and discount prices for tourist who have relatively elastic demand. The airlines enforce the scheme by making the tickets non-transferable thus preventing a tourist from buying a ticket at a discounted price and selling it to a business traveller (arbitrage). Airlines must also prevent business travellers from directly buying discount tickets. Airlines accomplish this by imposing advance ticketing requirements or minimum stay requirements conditions that it would be difficult for average business traveller to meet