Price discrimination (PO) occurs when units of the same product are sold at different prices not on account of cost differential but for the purpose of profit maximization, In other words, it is the selling of some units of a commodity at high prices and other units at low prices to different people or in different markets, states, countries etc, in order to enjoy the benefits of large-scale production and reap maximum profit. Price discrimination is also referred to as ‘multiple price system‘.

 

Definition

  1. It is the selling of units of the same product to different groups of people, states and countries at different prices.
  2. It is the act of selling units of a commodity in separate markets at different prices.

 



An example of multiple prices

Let us assume that 10 units of a notebook are sold at N25 each; the total revenue is therefore N250. If each notebook costs N20, the total profit is (N250 – 200) N50.00. This is a situation of non-price discrimination – single price system.

With the adoption of multiple price system, he will sell some units of the notebook at a higher price to those with high income or less bargaining power and other units at low prices to low income earners or people with high or tactful bargaining power. His total surplus profit will be much higher than when he adopts single (low) price system.

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Thus the major aim is to earn higher profit than that of single price system. In other words, it is designed to convert consumers’ surplus into producers’ pocket.

Perfect price discrimination occurs when the seller is able to extract the entire surplus of the consumers. However, in real world situation, perfect price discrimination is impossible.

 

Reasons for price discrimination

Some of them are as follow:-

  1. Profit maximization.
  2. To enlarge sales volume.
  3. To raise the level of production output in order to operate at optimum level – full capacity.
  4. To reap the benefits of large-scale production.
  5. To have a lion share of the market.

 

Factors that make price discrimination possible

Price discrimination is possible if:

  1. Elasticity of demand in each market is not the same.
  2. Markets are kept separate by a high tariff (tax rates).
  3. The goods are produced by a monopolist.
  4. The goods or services can’t be transferred e.g medical services especially surgery.
  5. The resale of the goods by one buyer to another can not be effected (done).

 

Price differences not representing price discrimination

They include the following:

  1. Wholesale and Retail Pricing: Wholesale prices are always lower than retail prices.
  2. Seasonal pricing: Prices during international festivals like Christmas, Easter, etc ., are relatively high. Also prices of rainy season goods like umbrella are always higher during the rainy season than in the dry season.
  3. Quantity discount: Prices are highly reduced when goods are bought in a very large quantity. That is, different discounts are given to different levels of high purchase.
  4. Transport cost: The cost of transporting the goods to distant locations, like foreign countries or rural areas may lead to high charges.

 

Success of price discrimination

The success of price discrimination depends on the following:-

  1. If a buyer at low prices can not resell the goods at “higher prices.
  2. If there is existence of high tariff wall (high tax rates like import and export duties), transport cost, import quotas, etc. that prevents re-export to home market.
  3. If there is no perfect or close substitute in the second (foreign) market within the same price range.

 

Price discrimination in two markets

A monopolist increases his profit by selling his output at different markets, assuming two markets: home and foreign markets. He sells at normal or high price in the home market; And he sells the additional or remaining output at a low price in the second market abroad.

How can he allocate his entire output among the two markets in order to maximize profit? The output or quantity sold in the two markers should be at the level that equates their marginal revenues (MRs). That is, the output that makes their MRs to be equal. In other words, he should sell quantity at which MR equal MC in each of the markets.

If this is not achieved, he has to re-allocate output among the two markets until the MRs in both markets are equal. And the optimum price in each” market is the price at which MR equals MC. The monopolist maximizes total profit in both markets when he sells output in each market that equates their MRS.

Elasticity of demand also influences the monopoly power in each of the markets. If the elasticity of demand is the same in each market, price discrimination is not possible. Why; It is because the monopolist can’t gainfully influence the price in any of the markets. That is, he can’t increase his profit through this practice.

“Price discrimination is possible if demand is elastic in one market and inelastic in another”.

In the market with elastic demand, price is less but volume of sale is more. And in the market with inelastic demand, price is higher but volume of sale is less. Thus he charges less price in the market with elastic demand and a higher price in the market with inelastic demand.

 

Organizations practising price discrimination

They include:

  1. Electricity corporations.
  2. Railways.
  3. Airlines.
  4. Medical services.
  5. Sports and musical outfits, etc.

 

Its advantages

  1. Increase in production output: Multiple price monopolists produce more than single-price monopolists as the former can sell his products in different markets.
  2. Poor can buy more goods: It enables low-income earners to afford acquiring certain goods or services as some discriminating monopolists, like doctors, sell at relatively low prices to them.
  3. It makes some businesses to survive: It enables monopolists to earn profit in certain ventures that would otherwise be unprofitable.

 

Its disadvantages

  1. Exploitation of consumers: It enriches producers at the expense of consumers as the latter pay higher prices for the same unit of a commodity. Thus consumers surplus are converted into producers revenue. That is, it reduces consumers surplus (income).
  2. Poor performance of local firms: It causes poor performance or collapse of local firms if foreigners sell their goods at foreign markets at prices that are lower than the prices at which the local firms sell their goods.

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