In this essay we are going to look at the reasons why a firm should price discriminate or alternatively why they should not price discriminate. Price discrimination in basic terms is when firms charge different prices for different goods and services. There are three different levels of price discrimination. First degree price discrimination is when a firm charges each customer a different price. For this type of price discrimination to be used a monopoly has to know the maximum amount a consumer is willing and able to pay thus allowing them to charge each customer the maximum price and therefore maximising the firms’ revenues. This is one of the reasons why firms should price discriminate which we will discuss in detail later in the essay. Moving on to the next level of price discrimination, which is Second degree price discrimination. This is when firms charge lower unit prices for larger quantities. This is particularly common in wholesale firms where most of their customers buy in bulk and therefore the more they buy the greater discount they can receive. The final level of price discrimination is Third degree price discrimination where a firm splits the market into segments and then charges each segment different prices. For instance some firms offer student discounts. For this to occur the segment has to be verifiable and it’s a sealed segment. For example students can be verified through ID cards and is also a sealed segment because a student discount cannot be used by anyone else. These are the three forms in which price discrimination can take place.
Having looked at the different forms of price discrimination we’re now going to look at reasons why firms should price discriminate. There are many benefits that can arise from price discrimination. One of the benefits is that it can be used as a method of earning higher profits if it is implemented effectively. It can allow a firm to capture some consumer surplus which can boost their earnings. The type of price discrimination method which allows you to capture this extra consumer surplus is First degree price discrimination.
Firms will charge a customer the maximum price they are willing and able to pay. The AR curve shows the willingness and ability of customers. At Q1 customers are willing to pay P1 and at Q3 customers are willing to pay P3. Both price levels of P1 and P2 are above the market equilibrium price of P5 where Marginal Cost (MC) is equal to Demand. Therefore when the firm charges any price above P5 they’re able to capture extra consumer surplus and turn it into producer surplus thus boosting their revenues and increasing profit. This type of price discrimination is one of the reasons for the case of firms should be price discriminating as it can allow them to earn more revenue therefore they should do it. This strategy of price discrimination requires a perfectly segmented market in order for the firm to identify who is willing to pay what price. It’s common in bidding markets where customers will bid for an item and therefore the person makes the purchase at the maximum price they are willing to pay. However in reality implementing first degree price discrimination strategy can be difficult as most markets are not and cannot be split into perfect segments. There will always be overlaps and therefore it will be difficult to charge different prices from different consumers.
Another case to support the argument that firms’ should price discriminate is that it can allow a firm to make the most out of their resources by utilizing capacity to maximum levels and capturing more customers in the market. Tim J. Smith the founder and Managing Principal of Wiglaf Pricing in his article on ‘The Case for Price Discrimination’ writes:
“…price discrimination… awakens a business to the opportunity of serving customers that don’t value the offering as highly but would like to purchase if prices were lower. Price discrimination…