What is price discrimination?
Price discrimination refers to a pricing strategy that charges different customers different prices for the same product or service. This is one of the common competitive practices used by larger, established businesses in an attempt to profit from differences in supply and demand in the market or target customers. In this pricing strategy, the seller charges each customer the maximum price that they perceive the customer would be willing to pay. In more common forms of discriminating prices, the seller groups customers on the basis of certain attributes and charges each group a different price.
Types of price discrimination
For pricing strategies to succeed, businesses must have a clear understanding of their customer base and its needs. The most common types of price discrimination used include:
First-degree price discrimination
It is also known as perfect price discrimination, occurs when a company charges the maximum possible price for each unit consumed. As prices vary among units, the firm captures all available consumer surplus for itself. In the modern business world, companies rarely practice such types of prices discrimination. In such types of price discrimination, businesses can accurately determine what each customer is willing to pay for a specific product or service. This makesit possible to sell that good or service for that exact price. However, it is time-consuming and difficult to master for most businesses. Here, sellers can capture the highest amount of available profit for each sale.
Second-degree price discrimination
It is a pricing strategy of charging a different price for different quantities consumed, such as quantity discounts on bulk purchases. Here, the ability to gather information on every potential buyer is not present. Instead, based on the preferences of various groups of consumers, companies price products or services differently. Businesses mostly apply second-degree price discrimination through quantity discounts; bulk purchasers tend to receive special offers and discounts that are not granted to those who buy a single product. This strategy does not completely eliminate consumer surplus, also it allows a company to increase its profit margin on a subset of its consumer base.
Third degree price discrimination
Third degree price discrimination occurs when different consumer groups are charged different prices. Third degree price discrimination is the most common strategies today that several players in the market are adopting. This pricing strategy provides a way to reduce consumer surplus by catering to the price elasticity of demand for specific consumer groups. Common examples of third degree price discrimination include admission prices to amusement parks, movie theater ticket sales, and offers in restaurants. Consumer groups that may otherwise not be able or willing to purchase a product are captured by this pricing strategy, which eventually increases the company’s profits.