Price Discrimination
"Price discrimination" is a technical term
meaning only differentiation in price by customer, and is not intended
as an accusation of criminal or unfairly biased behavior. Price discrimination
exists when sales of identical goods or services are transacted at different
prices from the same provider. In a theoretical market with perfect
information, no transaction costs or prohibition on secondary exchange
to prevent arbitrage, price discrimination can be a feature only of
monopoly markets.
Otherwise, the moment the seller tries to sell the same good at different
prices, the buyer at the lower price can arbitrage by selling to the
consumer buying at the higher price but with a tiny discount. However,
market frictions in oligopolies such as the airlines, and even in fully
competitive retail or industrial markets allow for a limited degree
of differential pricing to different consumers. Price discrimination
also occurs when it costs more to supply one customer than it does another,
and yet the supplier charges both the same price.
The effects of price
discrimination on social efficiency are unclear; typically such behavior
leads to lower prices for some consumers and higher prices for others.
Output can be expanded when price discrimination is very efficient,
but output can also decline when discrimination is more effective at
extracting surplus from high-valued users than expanding sales to low
valued users. Even if output remains constant, price discrimination
can reduce efficiency by misallocating output among consumers.
Price discrimination requires
market segmentation and some means to discourage discount customers
from becoming resellers and, by extension, competitors. This usually
entails using one or more means of preventing any resale, keeping the
different price groups separate, making price comparisons difficult,
or restricting pricing information.
The boundary set up by
the marketer to keep segments separate are referred to as a rate fence.
Price discrimination is thus very common in services, where resale is
not possible; an example is student discounts at museums.
Price discrimination can
also be seen where the requirement that goods be identical is relaxed.
For example, so-called "premium products" have a price differential
that is not explained by the cost of production. Some economists have
argued that this is a form of price discrimination exercised by providing
a means for consumers to reveal their willingness to pay.
The purpose of price discrimination is generally to capture the market's
consumer surplus.
Price discrimination transfers
some of this surplus from the consumer to the producer/marketer. Strictly,
a consumer surplus need not exist, for example where price discrimination
is necessary merely to pay the costs of production.
It is very useful for the
price discriminator to determine the optimum prices in each market segment.
This is done in the next diagram where each segment is considered as
a separate market with its own demand curve.
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