Question

a) Compare a firm's informational needs to engage in 1st, 2nd and 3rd degree price discrimination.

b) In second degree price discrimination, supposr who benefirs frım the presence of other group, high demand consumers or low demand consumers? Explain.

Answer 1

A) Price discrimination is a strategy that consists of a business or seller charging a different price to various customers for the same product or service. It is one of the competitive practices used by larger, established businesses in an attempt to profit from differences in supply and demand from consumers.

A company can enhance its profits by charging each customer the maximum amount he is willing to pay, eliminating consumer surplus, but it is often a challenge to determine what that exact price is for every buyer. The most common types of price discrimination are first, second, and third-degree discrimination.

First degree

First-degree price discrimination, alternatively known as perfect price discrimination, occurs when a firm charges a different price for every unit consumed. The firm is able to charge the maximum possible price for each unit which enables the firm to capture all available consumer surplus for itself. In practice, first-degree discrimination is rare.

Second degree

Second-degree price discrimination means charging a different price for different quantities, such as quantity discounts for bulk purchases.

Third-degree

Third-degree price discrimination means charging a different price to different consumer groups. For example, rail and tube travelers can be subdivided into a commuter and casual travelers, and cinema goers can be subdivided into adults and children. Splitting the market into peak and off-peak use is very common and occurs with gas, electricity, and telephone supply, as well as gym membership and parking charges. Third-degree discrimination is the commonest type. Conditions for successful discrimination:

1. The firm must be able to identify different market segments, such as domestic users and industrial users.

2. Different segments must have different price elasticities (PEDs).

3. Markets must be kept separate, either by time, physical distance and nature of use. Time-based pricing - also called dynamic pricing - is increasingly common in goods and services sold online. In this case, prices can vary by the second, based on real-time demand related to consumers' online activity.

4. There must be no seepage between the two markets, which means that a consumer cannot purchase at the low price in the elastic sub-market, and then re-sell to other consumers in the inelastic sub-market, at a higher price.

5. The firm must have some degree of monopoly power.

B) Second-degree price discrimination, or nonlinear pricing, involves setting prices subject to the amount bought, in an attempt to capture part of the consumer surplus. Revenues collected by the firm in this matter will be a nonlinear function. A bulk sale strategy, such as quantity discounts, will be applied and consumers will choose the block that better suits them.

In second-degree price discrimination, high-end demand consumers are more benefitted because they buy goods in bulk. a monopoly will be able to implement this type of price discrimination to a certain consumer by offering discounts for buying a higher quantity. By offering a lower price, for some quantity, the monopoly is able to extract part of the consumer surplus. This price discrimination works similarly to two-part tariffs. However, in this case, the monopoly won’t charge an entrance fee but will hide this entrance fee into part of the discounted price offered to the consumer.