Price Discrimination

You’ll be able to

State the three conditions required for price discrimination
Explain the effect of perfect price discrimination on output and surplus
Identify examples of price discrimination and the segmentation each relies on

Three conditions, all necessary

Price discrimination is charging different prices to different buyers for the same good. It requires all three of: market power — a price taker cannot do it; the ability to segment buyers by willingness to pay; and prevention of resale, since otherwise low-price buyers would resell to high-price ones and arbitrage the difference away. Remove any one condition and the strategy collapses.

Perfect price discrimination

each unit sold at the maximum any buyer will pay → MR curve becomes the DEMAND curve → produces where D = MC

Output rises to the allocatively efficient quantity and deadweight loss disappears — but the entire consumer surplus is captured by the producer.

The surprising efficiency result

Under perfect price discrimination the firm no longer has to cut the price on earlier units to sell one more, so marginal revenue equals demand. It therefore produces where demand crosses MC — the socially optimal quantity — and deadweight loss is zero. Efficiency improves. But every dollar of consumer surplus is converted into producer surplus, so consumers are worse off than under single-price monopoly. This is the cleanest example in the course of efficiency and equity pointing opposite ways.

Real-world segmentation

Student and senior discounts segment by observable characteristic correlated with willingness to pay. Airline advance-purchase rules segment business from leisure travelers by timing. Coupons segment by effort — those willing to spend time clipping them are more price-sensitive. Bulk discounts and two-part tariffs segment by quantity. In each case notice which of the three conditions is doing the work, and how resale is prevented — usually by tying the good to an identity or a moment in time.

Worked example

A cinema charges $16 for adults and $9 for students. Identify how each of the three conditions is met and state the effect on the cinema's revenue relative to a single price.

1.Market power: the cinema is not a price taker — it faces a downward-sloping demand curve for its screenings.
2.Segmentation: student status is observable through an ID card and correlates with lower willingness to pay.
3.No resale: the ticket is checked against the ID at entry, so a student cannot resell to an adult.
4.Effect: the cinema captures the adult's higher willingness to pay while still selling to students who would not pay $16.

Answer: All three conditions are satisfied. Revenue exceeds what a single price would yield, because the cinema no longer has to choose between pricing out students and undercharging adults. Attendance is also higher than under a single high price.

Watch out

Charging different prices because costs differ is not price discrimination. A first-class airline seat costs more to provide. Price discrimination means different prices for the same good at the same cost, differing only in what the buyer will pay.

Checkpoint

Which condition is NOT required for price discrimination?

Checkpoint

Compared with a single-price monopoly, perfect price discrimination results in:

Checkpoint

Airlines charging more for tickets bought the day before departure is price discrimination that segments buyers by:

On the exam

When asked whether a pricing practice is discrimination, check explicitly whether the cost of serving the two groups differs. If it does, the practice is cost-based pricing and the answer is no.

Answer the 3 checkpoints as you read.