Tuesday, May 11, 2010

The Degree of Price Discrimination

Price discrimination is the practice of one retailer, wholesaler, or manufacturer charging different prices for the same items to different customer. This is a widespread practice that does not necessarily imply negative discrimination. Early forms of price discrimination certainly existed in Jim Crow law states, where a black consumer might very likely pay more for the same quantity and items than a white consumer would. In general, this type of price discrimination is very rare today.

Price discrimination, as it is now understood, is separated into three degrees. First, second and third degree price discrimination exist and apply to different pricing methods used by companies. Much depends on the understanding of the market in segments, and also the consumer’s ability to pay a higher or lower price, called elasticity of demand. A person who might pay more for an item is thought to have a low elasticity of demand. Another person who will not pay as much has a high elasticity of demand.
First-degree price discrimination occurs when identical goods are sold at different prices to each individual consumer. Obviously, the seller is not always going to be able to identify who is willing to pay more for certain items, but when he or she can, his profit increases. You can see this type of price discrimination in the sale of both new and used cars. People will pay different prices for cars with identical features, and the salesperson must attempt to gauge the maximum price at which the car can be sold. This type of price discrimination often includes a bargaining aspect, where the consumer attempts to negotiate a lower price.
Second-degree price discrimination refers to companies charging lower prices for higher quantities. In companies where a client orders in bulk and is able to purchase a high number of the same items at once, the client may get a discounted rate. This rate would not apply to a client who only orders a few items at a time. In retail stores, second-degree price discrimination often exists. A reduced price may be offered if you buy two t-shirts instead of just one. This form helps to get rid of merchandise and generate more revenue for a company.
Third degree price discrimination is based on understanding the market, and occurs with great frequency. This type takes many different forms, but in all cases attempts to derive the most sales from each segmented “group” of consumers. For example, senior citizens are considered a group, and are often offered discounts at movie theaters, for transportation, in restaurants, and even in retail stores where seniors may have a “senior day” each week that allows them to take a discount on merchandise. “Students” are another segmented group that may be offered lower prices. Both seniors and students have a higher elasticity of demand and can generally afford to pay less than the average worker.
Market segmentation may also evaluate the socio-economic aspects of an area when considering elasticity of demand. It’s not uncommon to see retail grocery stores offer differing prices in an area where the retailer knows he can get more money for a product. Alternately, where only one chain store exists in a certain location, retail grocery stores might offer higher prices because people have no alternative place to shop.
Another form of third degree price discrimination is temporary discounts for airfares that are meant to increase business. These discounts could be seasonal, and designed to promote the company. Those in urban areas may pay more for flights or hotel rooms than those in rural areas.

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