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Price Discrimination

Updated on April 11, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Price Discrimination?

Price discrimination is a pricing strategy whereby firms sell the same products or services at different prices in different markets. It is the means adopted to ensure healthy competition by letting consumers purchase goods at a reasonable yet different rate than the competitors. . The strategy helps brands sell more, leaving their rival brands behind.

Price Discrimination

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The price discrimination strategy is most effective in a monopolistic market, where sellers can determine the prices without obeying any standard pricing mechanisms, rules, or laws. It is different from product differentiation, where the distinction is made between the products and not their prices.

Key Takeaways

  • Price discrimination is charging prices for the same goods in various markets.
  • There are various types of price discrimination, such as personalized pricing, product versioning, direct segmentation, complete discrimination, group pricing, etc.
  • Price discrimination happens in the wedding industry, airlines, property rates, and retail prices. 
  • The poorer segments of society are deprived of products and services due to high market prices and low standards of life. Therefore, it also helps them gain an economic edge.

Price Discrimination Explained

Price discrimination strategy occurs when sellers decide to make more profit by determining a reasonable price, which consumers are willing to pay. This is a strategy adopted to ensure boosting the sales figures. The prices can either be more or less, given the ability of the consumers to pay and their consumption habits and situations.

When competition is high, every business in the market tries to leave its competitor behind. As a result, they keep the pricing as lenient as possible. In the process, the sellers divide customers into different segments depending on their demographics and preferences. Furthermore, they fix separate prices to be paid for a product or service purchased by those groups.

The strategy works effectively only when the company enjoys a monopoly in the market. Secondly, the customer’s interests and preferences matter as to how unique a product to be sold is. Finally, when the brands shift the prices of the products in the different markets under monopoly price discrimination, it maximizes profits for businesses, thereby reducing costs for most customers.

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Types

Degrees of price discrimination occurs in various forms, including first degree, second degree, and third degree. 

Price Discrimination Types

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  1. First degree price discrimination, also referred to as perfect price discrimination, is the strategy whereby firms fix the maximum price for each unit of product and service. As the ability of consumers to bear the cost of products is hard to determine, companies refrain from adopting this strategy. Consumer surplus is nowhere in this type of cost discrimination.
  2. Second degree price discrimination refers to the price set per the quantity consumed. It is also known as product versioning or menu pricing. It may also involve creating a different product lineProduct LineProduct Line refers to the collection of related products that are marketed under a single brand, which may be the flagship brand for the concerned company. Typically, companies extend their product offerings by adding new variants to the existing products with the expectation that the existing consumers will buy products from the brands that they are already purchasing.read more similar to a menu card in which more options are given for the same product with minor changes to sell them at a differential price. For example, a mobile data recharge plan is priced differently from the amount of data used.
  3. Third degree discrimination, also termed group pricing, occurs when firms divide their consumers into different groups and sell the same products at different prices to specific groups. For example, infants can enjoy a flight free of cost, while anyone above two has to pay for the flight tickets.

Conditions

Though price discrimination strategy is one of the most effective strategies for boosting sales, not all companies have the liberty to implement it. There are certain criteria or requirements that a firm needs to fulfill to adopt any such strategy. Some of the conditions include:

Price Discrimination Conditions

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#1 – Firm’s Monopoly

When the firm has a monopoly in the market, it becomes the price makerPrice MakerPrice maker (P-M) refers to a firm having enough market power to control the market prices of its products and services without losing its customers.read more. An imperfect marketImperfect MarketImperfect market structure is a part of microeconomics in which companies sell different products and services, as opposed to perfect competitive markets in which homogeneous products are sold. Companies in this sector have some pricing power with high barriers to entry, resulting in higher profit margins as each company tries to differentiate their products and services through innovative technology.read more gives companies the liberty to opt for such cost strategies.

#2 – Market Segmentation

Segmenting markets to make this pricing strategy work is a must. Thus, companies need to divide the markets based on various factors, including age, gender, preferences, physical distance, nature of the product, time, etc. Based on this division, companies can implement dynamic pricingDynamic PricingDynamic pricing is a pricing strategy that ignores fixed pricing and instead uses variable pricing, or in other words, it is a strategy in which the price of a specific product changes in response to ongoing customer demand and supply.read more strategies based on the time of sale or the demand for a product.

The market segments should be divided such that no two markets get entangled at any cost. The seepage of one market into the other would mean resale facilitation. As a result, the entities that purchase the goods and resell them at a lower rate would start getting direct customers, making the original sellers incur huge losses. Thus, it is important to prevent resale opportunities.

#3 – Elasticity Of Demand

Furthermore, the elasticity of demand greatly determines which forms of price discrimination would work for a company. For example, a lower income group searches for options that involve less expenditure; hence, they narrow down their options as elastic. On the other hand, the higher income groups are ready to spend more, are open to more comprehensive opportunities, and have more demands. 

This elasticity level of the lower income group might restrict the effectiveness of such a pricing strategy, while the inelasticity of demand among higher income groups could make it work.

Examples

Let us consider the following price discrimination examples to understand how the strategy works:

Example #1

In the case of weddings, the seller of the goods and services may charge a slightly higher price than its usual charges, taking advantage of the event to earn more, thereby highlighting the benefits of price discrimination.

Example #2

The wholesalers of the goods and services may charge a differential pricing strategy to the retailers who buy in bulk compared to those who buy in small quantities. For example, they might offer hefty discounts for bulk purchases.

Example #3

In the case of a flat, the per-square-feet rate for one area may be very expensive due to the location accessibility, and facilities, while the same flat may have a lower price if located in another area.

For example, 400 square feet flat in New York might cost $5,00,000 since New York is the financial capital of the United States of America, while the same 400 square feet flat might cost only $300,000 in New Jersey, the city being comparatively less expensive to live in. The benefits of price discrimination, here, is based on the location, connectivity, facilities, etc.

Advantages & Disadvantages

Though different forms of price discrimination seem to support a market positively, some cons might restrict businesses from adopting this strategy. So, let us have a look at the advantages and disadvantages of the concept in a tabular form below:

AdvantagesDisadvantages
Businesses sell more, generate better revenuesPrices go too high in some cases
Lenient pricing helps lower-income groups to buy products at a lower costConsumer surplus is no option
As the cost is adjusted, sales increase and the output level automatically improves (economies of scale)Might hamper the company’s image as the same products might be available at lower prices in other markets
Helps even the deprived sections have a better standard of living 

Price Discrimination Vs Dynamic Pricing

Price discrimination is the idea of charging different prices for same products, whereas dynamic pricing is making price adjustments based market forces. Let us look at the basic differences between them.

Price DiscriminationDynamic Pricing  
Method of charging different prices for same products.Method of adjusting prices.
It depends on how much customers are willing to pay.It depends on market forces of demand and supply.
It helps the individual business earn maximum revenue.It helps the entire economy because the market forces determine prices.

Frequently Asked Questions (FAQs)

What are the types of price discrimination?

Their lack of access to goods and services due to high market prices and a low standard of living also helps the poorer segments of society gain an economic edge.

Is price discrimination ethical?

Price discrimination that violates antitrust or price-fixing laws or is based on a person’s race, religion, nationality, or gender is illegal.

What is perfect price discrimination?

Perfect pricing discrimination is another name for first-degree price discrimination. A corporation will charge as much as possible for each unit they sell in this kind of pricing discrimination. Prices for the many things sold as a result vary.

This is a guide to what is Price Discrimination. We explain it with examples along with types, conditions, advantages and disadvantages. You can learn more about finance from the following articles –

Reader Interactions

Comments

  1. Samantha Minnitt says

    Thank you so much for the information.

  2. Deborah says

    i have learnt alot from this webpage. thank you for this article. Can i know when was is updated to the website for the help of citation please?

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