Price discrimination is the practice of selling the same good or service at different prices to different people, or at different prices to the same person, for reasons irrespective of cost. In doing this, sellers attempt to capture additional profit from buyers who are willing to pay more.
There are three degrees of price discrimination, ranked by effectiveness at capturing the consumer surplus for the producer. First-degree price discrimination targets individuals by pricing the commodity at how much they value it (i.e. on their demand curve). Second-degree price discrimination offers the good in varying quantities, with a different per-unit price depending on how much is bought (for example, by offering an "economy size"). Third-degree price discrimination divides the consumers into groups (such as students or the elderly) and offers different groups different prices. While price discrimination is typically thought of as exploitative of consumers, second- and third-degree price discrimination can make the good more affordable in some cases, thus contributing to some consumers' welfare.
Some types of price discrimination can hurt the free market, such as hospitals' practice of charging self-paying patients far more than what hospitals charge insurance companies for the same service.
Requirements for Price discrimination
There are three general requirements for price discrimination:
- The firm must have market power. That is, it must face a downward-sloping demand curve. Perfectly competitive firms are price takers and cannot price discriminate.
- Buyers with differing demand elasticities must be separable. This is the case for consumers of different ages, from different locations, and so on.
- The firm must be able to prevent the resale of its goods so that those paying the lower price cannot resell their goods to those who should pay the higher price.