Meaning of Price Discrimination

• Price discrimination = practice of a seller charging different prices for the same product to different buyers. It is undertaken only when it is both possible and profitable for the seller. Example: selling the same model of refrigerator at Rs. 5,000 to one buyer and Rs. 5,500 to another buyer under identical conditions of sale and delivery constitutes price discrimination.

• In reality, such direct price discrimination is not very common because charging different prices for an identical product to different buyers is difficult. More commonly, sellers slightly differentiate the product to make price discrimination feasible.

• The concept can therefore be broadened to include the sale of different varieties of the same good at prices that are not proportional to their marginal costs. According to George Stigler, price discrimination is the sale of technically similar products at prices not proportional to marginal costs.

• Under this broader definition, price discrimination exists when different varieties of the same good are sold at different prices and the price differences exceed or do not correspond to cost differences. Example:

  • Ordinary edition of a book costs Rs. 58 per unit and deluxe edition costs Rs. 65 per unit.

  • If sold at Rs. 70 and Rs. 130 respectively, the price difference is Rs. 60 while the cost difference is only Rs. 7.

  • Since the difference in prices is not proportional to the difference in costs, the publisher is practising price discrimination.

• Although this broader form of price discrimination is highly relevant, it is more complicated. For analytical convenience, the discussion is restricted to the simpler case of selling the same product at different prices to different buyers, while the conclusions derived are generally applicable to the more complex form as well.

• Three types of price discrimination are identified:

  • Personal discrimination: different prices are charged to different individuals for the same product.

  • Local discrimination: different prices are charged in different places or localities; e.g., a producer may sell a commodity at one price in the domestic market and another price in foreign markets.

  • Discrimination according to use or trade: different prices are charged depending on the use of the commodity; e.g., electricity is often supplied at a lower rate for domestic consumption than for commercial purposes.

Degrees of Price Discrimination

• A. C. Pigou classified price discrimination into three types: first-degree, second-degree, and third-degree price discrimination, based on the manner in which a seller extracts revenue from buyers.

• First-degree price discrimination (Perfect Price Discrimination) involves the maximum possible exploitation of each buyer in the interest of the seller’s profits. It occurs when a monopolist is able to sell each separate unit of output at a different price, charging every buyer exactly the maximum amount he is willing to pay rather than forgo the commodity. Under this form of discrimination, the seller captures the entire benefit from exchange and leaves no consumer’s surplus to any buyer.

• Second-degree price discrimination occurs when a monopolist charges different prices for different blocks or quantities of a commodity and thereby appropriates only a part of consumer surplus, not the whole of it. The price generally declines with larger purchases. Example:

  • First block of 10 units charged at Rs. 50 per unit.

  • Next block of 10 units charged at Rs. 40 per unit.

  • Additional units charged at Rs. 30 per unit.

  • By using block pricing, the monopolist extracts part of the consumer surplus while still leaving some surplus with buyers.

• Third-degree price discrimination occurs when the seller divides buyers into two or more separate sub-markets or groups according to their price elasticity of demand and charges different prices in different sub-markets. The price in each sub-market depends on:

  • The quantity sold in that sub-market.

  • The demand conditions prevailing in that sub-market.

• Third-degree price discrimination is the most common form of price discrimination in practice. Examples:

  • A manufacturer sells the same product at a higher price in the domestic market and at a lower price in foreign markets.

  • An electric company charges a lower price to households and a higher price to manufacturers or commercial users.

• For analytical purposes, the subsequent discussion assumes only third-degree price discrimination because it is both more practicable and most commonly observed in the real world.