Do you ever drive to a different part of town and say to yourself, “Wow, gas is so much more expensive here!”?
Or maybe you’ve thought to wait to buy tickets to a sporting event in hopes that they’ll drop in price.
Both of these are common examples of price discrimination. In fact, price discrimination happens more often than you think, you just need to know the signs to look for.
Price discrimination is a pricing strategy that charges customers varying prices for goods or services based on certain criteria or what the seller believes the customer will agree to pay.
It’s important to remember that price discrimination charges customers a different price for the same product or service based on a specific bias toward a group of people or specific characteristics. For example, the product or service may be a different price for adults versus senior citizens or domestic buyers versus international buyers.
The point of doing so is so a seller can capture the consumer surplus. Their goal with price discrimination is to generate the most revenue possible for the product or service they are offering. It is most valuable for the seller to utilize price discrimination when there is a profit to be earned by when markets are separated.
When sellers go about price discrimination, they look at the type of market their product or service is in. For instance, if it's within an elastic market the price can change the demand of the product. But, if it's within an inelastic market, the demand won't change when the price changes.
For those who are visual learners, let's break it down.
If the marginal cost (MC) of a product or service is consistent across all market, whether or not it's divided, it will equal the average total cost (ATC). Maximum profit occurs at the price and output where MC is equal to marginal revenue (MR).
However, if the market is separated, then the price and output of a product in an inelastic market will be P and Q, while P1 and Q1 in an elastic sub-market.
Image Source: Economics Online
Types of price discrimination
There are three types of price discrimination that you can encounter: first-degree, second-degree, and third-degree. These degrees sometimes go by other names: personalized pricing, product versioning or menu pricing, and group pricing, respectively.
First-degree price discrimination, or perfect price discrimination, happens when a business charges the maximum possible price for each unit.
Since prices vary for each unit, the company selling will collect all consumer surplus, or economic surplus, for itself. In many industries, a company will commit first-degree price discrimination by determining the amount each customer is willing to pay for a specific product, and selling that product for that exact price. This can be done using market research strategies in addition to using budgeting and forecasting software.
Related: Interested in learning more about budgeting and financing software to plan for the future of your business? Read the reviews on some of your options!
Second-degree price discrimination, otherwise known as product versioning or menu pricing, happens when a company charges a different price for varying quantities consumed, such as offering a discount on products purchased in bulk.
Third-degree price discrimination, or group pricing, is when a company charges a different price to a specific consumer group. This is the most common type of price discrimination.
There are many industries that use price discrimination.
For example, when a consumer purchases airline tickets several months in advance, they will typically pay less than a consumer who purchases a ticket for the same flight two days before. This is because when the demand for a particular flight is high, airlines raise the ticket prices as a response. Similarly, airlines will get passengers to pay more for added perks, like legroom.
Another example would be how movie theaters, restaurants, or amusement parks often offer senior discounts for those over a certain age, or student discounts for moviegoers with a school ID.
There’s also the example of warehouse retailers, like Costco, that sell bulk items at discounted prices, as well as loyalty or reward cards for frequent customers. And, any time there is a “Ladies Night” at a bar or club that offers a different price for women is also a unique form of price discrimination.
Some others examples that fall within price discrimination:
Whether you're a seller or a consumer, there are advantages and disadvantages to price discrimination.
If you're a business looking to utilize price discrimination, some advantages include:
On the other hand, price discrimination can result in some disadvantages, too, especially for the consumer. They include:
And sometimes the price you pay is more than what someone else would pay. It’s more common than you think, and moving forward you will hopefully be able to spot price discrimination in action.
When you're done considering price, learn more about the four types of market segmentation, in addition to the most common mistakes.
Mara is a Senior Content Marketing Specialist at G2. In her spare time, she's typically at the gym polishing off a run, reading a book from her overcrowded bookshelf, or right in the middle of a Netflix binge. Obsessions include the Chicago Cubs, Harry Potter, and all of the Italian food imaginable. (she/her/hers)
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