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1st Degree Price Discrimination follows the definition above but is charging a different
price based on the customer.
2nd Degree Price Discrimination is charging a different price based on quantity sold.
3rd Degree Price Discrimination is charging a different price based on location of
customer segment.
1st Degree Price Discrimination
This type of discrimination, also known as perfect price discrimination, essentially states the
company charges the consumer the maximum price that individual is willing to pay for that
product. This extracts all the consumer surplus and earns the firms the highest possible profits.
This method of discrimintation is also one of the most difficult to adopt because it requires the
company knows each of its customers perfectly at each level of consumption (Baye, 2006). This
can best be seen in car dealers, where the price on the car is negotiable, and the dealers job is
to get the most out of the consumer as possible, the consumer surplus will be 0. In some
cultures, bargaining for goods and services, i.e., first degree price discrimination is the norm. In
others, first degree discrimination is much less prevalent and consumers are more used to
prices which are not negotiable. The aim of first degree price discrimination is for the firm to
appropriate the entire consumer surplus (see fig. 1,2, and 3).
Figure 1
Figure 2
Figure 3
This discrimination allows the firm to appropriate more, but not all, of the consumer surplus, fig.
6.
Figure 6
Firms can often segment the market by charging different amounts for providing the product or
service at different times, e.g. Weekend rail fares. The firm can also change the basic product in
some way, for example offering faster check-in for flights, slightly more legroom and
complimentary drinks. These firms can also segment markets by location, selling in different
places at different prices, car sales are an example of this. Car prices tend to be different in
different countries and these differences in prices cannot always be explained away.
Examples of 3rd degree price discriminators:
Wall street journal (student pricing), movie theaters (student & senior discounts), hotels (senior
discounts).
Benefits and costs of price discrimination
These of course depend on whether you are the firm or the consumer. Price discrimination
means that consumer surplus can be appropriated, and as long as the cost of the marketing
scheme (adverts, identity cards, ticket inspectors etc.) is less than the extra revenue the
scheme brings in then it is advantageous to the firm. At first sight it would seem the loser is the
consumer. But a second examination reveals that students are gaining, they pay less than if
there was a single market price. But an even deeper examination shows how adults might gain.
If by price discriminating the firm can increase output substantially, the average costs may fall
because of economies of scale. These economies may even outweigh the price difference
between adults and students. In conclusion, it is necessary to look at price discrimination on a
case-by-case basis.