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Price discrimination arises if a firm is able to charge different price to different groups of people and gain their consumer surplus. There are three conditions that have to be met in order to achieve price discrimination:

1. The firm must be a price maker in the market - price discrimination can only take place under monopoly or monopolistic competition.
2. The firm must be able to identify different groups of customers and know their different elasticities of demand.
3. There can be no resale in the market between consumers. This is known as arbitrage.

Contents 1 Effects of price discrimination 2 First degree price discrimination 3 Second degree price discrimination 4 Third degree price discrimination 5 Comments

Effects of price discrimination

• Buyers lose their consumer surplus to the monopolist
• Profits rise for the monopolist
• Some consumers gain a good or service that they might otherwise not have been able to have

First degree price discrimination

Also known as perfect price discrimination.

The firm separates the whole market into each individual consumer and charges them the price they are willing to pay. The firm extracts all the consumer surplus and turns it into revenue. The firm will sell up to the point where AR = MC. Beyond this point the price consumers are willing to pay is less than it costs the firm to make.

Examples: haggling, bartering.

Second degree price discrimination

Occurs in markets where there is a fixed capacity so it is in the firms interest to "fill every seat", and the firm is prepared to sell at cost to achieve this. Tends to occur where there are high fixed costs. For example, it costs much the same to fly a Boeing 747 whether there is 1 passenger on it or hundreds.

The firm begins by selling at the profit maximising point (MC=MR). However this leads to spare capacity. The firm then reduces the price to P1 to sell the remainder.

Examples: theatre tickets, plane tickets (last minute tickets cost less), football tickets in lower divisions ("kid for a quid" - adds to revenue but adds little to costs).

Third degree price discrimination

This is charging different prices to groups with different elasticities. The monopolist charges a lower price to a group of people who have more elastic demand.

Examples: telephone charges (more elastic demand in evenings), rail tickets (young persons railcard - students are more price sensitive), gender pricing in nightclubs.

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