Price Discrimination

Price discrimination occurs when a seller with some market power charges DIFFERENT prices for the SAME product to different buyers or in different markets, where the price difference is NOT justified by any difference in the cost of supplying them. It is possible only for a firm facing a downward-sloping demand curve (some price-setting power) — a perfectly competitive firm, being a pure price taker, can never practise it.

Two conditions must both hold for price discrimination to be both POSSIBLE and PROFITABLE:

1. Market separation: the seller must be able to keep the markets/buyer-groups genuinely separate, so a buyer who purchases at the lower price cannot resell to a buyer facing the higher price (no arbitrage) — separation can be geographic, based on the nature of use of the product, or based on buyer characteristics like age or income.
2. Different price elasticities of demand: the separate markets must have genuinely different price elasticities of demand — the firm charges a HIGHER price in the market with the LESS elastic (more inelastic) demand, and a LOWER price in the market with the MORE elastic demand.

A. C. Pigou's classification identifies three "degrees" of price discrimination:

• First-degree (perfect) discrimination: the seller charges each individual buyer the maximum price that buyer is willing to pay for each unit — theoretically extracts the entire consumer surplus, rarely achievable in practice except in very specific settings (e.g. a doctor privately charging patients according to perceived ability to pay).
• Second-degree discrimination: the seller charges different prices for different BLOCKS of quantity purchased by the same buyer (e.g. a lower per-unit electricity tariff for consumption beyond a certain block).
• Third-degree discrimination: the seller divides buyers into distinct groups/markets (e.g. student vs. general railway fares, domestic vs. export pricing) and charges a different — but uniform within each group — price to each group; this is the most commonly observed form in practice. …