A2 UNIT 3

Ch-7 : Price Discrimination

7.1 Price Discrimination

Price discrimination is said to occur when a monopoly is selling the

same good/service at different prices to different consumers.

Conditions necessary for price discrimination to take place:

• The monopolist must be able to split the market into separate sub-
markets.

• Each sub-market must have different values of price elasticity of

demand.

• The monopolist must be able to prevent arbitrage (no resale possible

between consumers)

7.2 First Degree

First degree price discrimination occurs when a firm charges the

maximum amount which a consumer is willing to pay. The entire
consumer surplus is taken away be the producer. E.g. During auctions or
haggling, e.g., to some extent, the seller can extract a huge amount of
consumer surplus away from the buyer.

7.3 Second Degree

Second degree price discrimination occurs when consumers are

charged different prices based on their consumption levels. For example,
a taxi may charge £2.50 for the first mile, and then £1.50 for the second,
and then £1 for each mile after that. Telephone, electricity and gas
companies can also price discriminate in this manner.
7.4 Third Degree

Third degree price discrimination occurs when the monopolist splits

the consumers into two or more separate groups. Prices charged to each
group will be different, depending on elasticity of demand. Groups with
inelastic demand will be charged higher prices.

In this diagram, the monopolist has split the total market into two sub markets
A and B. In Market A, demand is inelastic, and therefore the price charged is
higher compared to Market B, where demand is relatively more elastic. This
allows the monopolist to increase its supernormal profits

Arguments in favour of price discrimination:

• It allows low income groups to consume a good/service at a lower price.

They may not have been able to afford it otherwise. E.g. economy class
travellers
• A firm can raise its revenue, which may allow it to stay in business. The
increased profits may be used to finance research.

Arguments against price discrimination:

• It takes away a large portion of consumer surplus away from those who
are paying a higher price.
• Does not always necessarily benefit low income groups, e.g. a rich
pensioner will receive a discount, whereas an unemployed 30 year old
will not.
• Price charged is above marginal cost, therefore it is allocatively
inefficient.