Price Discrimination

Price Discrimination

Price discrimination is the sale of the same goods to different buyers at different prices (with the same costs). It is a way for a monopolist to extract more profit by exploiting differences in willingness to pay.

Conditions for Price Discrimination

1. Market power: the ability to set prices.
2. Ability to segment the market: identifying groups with different elasticities.
3. Impossibility of arbitrage: buyers cannot resell the good between segments.

Degrees of Price Discrimination

First Degree (Perfect price discrimination):

• Each buyer receives their own price equal to their willingness to pay.
• Extraction of all consumer surplus.
• Ideally efficient (no DWL) — quantity equals competitive level.
• Practically impossible — requires knowledge of individual preferences.
• Approximation: auctions, individual negotiations.

Second Degree (Quantity-based):

• Price depends on the quantity purchased.
• Self-selection — buyers choose their own “package.”
• Examples: wholesale discounts, “the more, the cheaper” tariffs.
• Block pricing, two-part tariffs.

Third Degree (Segment-based):

• Different prices for identifiable groups.
• Groups differ in demand elasticity.
• Examples: student discounts, children's tickets, prices for different countries.
• Most widespread form.

Optimal Third-Degree Discrimination

Rule: MR1 = MR2 = MC

Marginal revenue in each segment must equal marginal cost.

Consequence: higher price for the segment with less elastic demand.

$ \frac{P_1}{P_2} = \frac{1 - 1/|PED_2|}{1 - 1/|PED_1|} $

Examples of Price Discrimination

• Airline tickets: Business class vs economy.
• Advance purchase discounts.
• Saturday night stay requirement.
• Dynamic pricing.
• Pharmaceuticals: High prices in wealthy countries, low in poor (differential pricing).
• Software: Student licenses.
• Enterprise vs personal.
• Freemium models.
• Cinemas: Discounts for students, seniors.
• Morning showings are cheaper.

Two-part Tariffs

Two-part tariff: fixed fee + variable per unit.

Examples:

• Club memberships + service fees.
• Amusement parks: entrance + rides.
• Telephone service: subscription fee + per-minute charge.

Optimal two-part tariff:

• Variable part = MC (efficient quantity).
• Fixed part = consumer surplus at P = MC.
• Full extraction of CS.

Bundling

Pure bundling: products sold only together.

Mixed bundling: can be bought separately or together.

When bundling is beneficial:

• Negative correlation of values: those who highly value A, value B low, and vice versa.
• Reduces dispersion in willingness to pay.

Examples: Microsoft Office, cable packages, combo meals.

Welfare Effects

• First degree: efficient (no DWL), but all surplus goes to seller.
• Third degree: May increase or decrease overall welfare.
• If opens new markets (previously unserved) — positive.
• If simply redistributes — ambiguous.

For the Investor

Price discrimination = extraction of value:

• Companies with effective discrimination extract more profit.
• Data and analytics allow better segmentation.

Indicators:

• Many pricing plans.
• Price personalization.
• Geographic pricing.
• Dynamic pricing (surge pricing).

Risks:

• Regulatory attention.
• Consumer backlash.
• Arbitrage (parallel imports).