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January 21, 2018 

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RESOURCE: The labor, capital, land, and entrepreneurship used by society to produce consumer satisfying goods and services. Land provides the basic raw materials--vegetation, animals, minerals, fossil fuels--that are inputs into the production of goods (natural resources). Labor is the resource that does the "hands on" work of transforming raw materials into goods. Capital is the comprehensive term for the vast array of tools, equipment, buildings, and vehicles used in production. Entrepreneurship is the resource that undertakes the risk of bringing the other resources together and initiating the production process.

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PRICE DISCRIMINATION:

The act of selling the same good to different buyers for different prices that are not justified by different production costs. This is practiced by suppliers who have achieved some degree of market control, especially monopoly. Common examples of price discrimination are electricity rates, long-distance telephone charges, movie ticket prices, airplane ticket prices, and assorted child or senior citizen discounts. Price discrimination takes the form of one of three degrees: (1) first degree, in which each price is the maximum price that buyers are willing and able to pay, (2) second degree, in which price is based on the quantity sold, and (3) third degree, in which prices are based on an easily identifiable characteristic of the buyer.
Price discrimination is a technique used by sellers to extract the maximum price possible from buyers, which has the obvious and direct implications of increasing the revenue and profit received by the seller. This is accomplished by transferring consumer surplus from buyers to sellers.

Three Conditions

To be a successful price discriminator a seller must satisfy three things: (1) to have market control and be a price maker, (2) to identify two or more groups that are willing to pay different prices, and (3) to keep the buyers in one group from reselling the good to another group. In this way, a seller is able to charge each group what they, and they alone, are willing to pay.
  • Market Control: First and foremost, a seller must be able to control the price. Monopoly is quite adept at price discrimination because it is a price maker, it can set the price of the good. Oligopoly and monopolistic competition can undertake price discrimination to the extent that they are able to control the price. Perfect competition, with no market control, does not do well in the price discrimination arena.

  • Different Buyers: The second condition is that a seller must be able to identify different groups of buyers, and each group must have a different price elasticity of demand. The different price elasticity means that buyers are willing and able to pay different prices for the same good. If buyers have the same elasticity and are willing to pay the same price, then price discrimination is pointless. The price charged to each group is the same in this case.

  • Segmented Buyers: Lastly, price discrimination requires that each group of buyers be segmented and sealed into distinct markets. Segmentation means that the buyers in one market cannot resell the good to the buyers in another market. Price discriminate is not effective if trade among groups is possible. Those buyers charged a higher price cannot purchase the good from those paying the lower price instead of from the seller.

Three Degrees

Price discrimination can take one of three forms (or degrees):
  • First-Degree Price Discrimination: Also termed perfect price discrimination, this form exists when a seller is able to sell each quantity of a good for the highest possible price that buyers are willing and able to pay. In other words, ALL consumer surplus is transferred from buyers to the seller.

  • Second-Degree Price Discrimination: Also termed block pricing, this form occurs when a seller charges different prices for different quantities of a good. Such discrimination is possible because the different quantities are purchased by different types of buyers with different demand elasticities. Block pricing of electricity, in which electricity prices depend on the amount used, is the most common example. The key is that regular households tend to use very little electricity compared to retail stores, which uses less compared to large manufacturing firms.

  • Third-Degree Price Discrimination: This is the most common of price discrimination. It occurs when the seller is able to separate buyers based on an easily identifiable characteristic, such as age, location, gender, and ethnic group. Senior citizen discounts are a common example. Higher gasoline prices near highways versus inside cities is another.

Two Groups, Two Prices

The general process of price discrimination can be illustrated using the hypothetical Shady Valley Cineramaplex, which has 20 movie screens and is the only movie theater in the greater metropolitan Shady Valley community. This gives the Cineramaplex extensive market control. It also provides the opportunity to practice price discrimination.

With market control, the Cineramaplex has the ability charge different prices to different "types" of movie goers. Suppose the Cineramaplex decision makers have evidence that two distinct groups of ticket buyers have distinctively different price elasticities of demand. For the sake of simplicity, other groups of movie goers are ignored in this analysis.

  • Youthful movie patrons, those in the 13 to 18 year age group, are not very responsive to ticket prices. In other words, they have a less elastic demand and are willing to pay relatively high prices to see a movie.

  • By way of contrast, older folks, those in the 50-plus age range, are more selective in their ticket purchases and thus have a relatively elastic demand. They are not as inclined to pay high ticket prices.
Age is the key factor that lets the Cineramaplex segment and seal each market demand. Youngsters can be charged one price and given a ticket that only admits youthful individuals. Oldsters can be charged another price and given tickets that only admits elderly individuals. Tickets cannot be traded between the groups because only those with the proper aged-based tickets are allowed entry into the Cineramaplex.

Price Discrimination
Price Discrimination


The goal of the Cineramaplex, like any firm, is to maximize profit. It does this by equating marginal revenue and marginal cost. The curve labeled MC in the exhibit to the right is the marginal cost curve for the production of this good. This is one side of the profit-maximizing decision. However, because the Cineramaplex can identify two groups of movie patrons, each with a different price elasticity of demand, there are two different marginal revenue curves (and associated demand curves) on the other side of the decision.

Each of the two groups--the youngsters and the oldsters--has its own demand curve. And with each demand curve comes a corresponding marginal revenue curve. Because the Cineramaplex has the power to control prices and can segment and seal each demand, price discrimination is bound to arise.

Consider how the Cineramaplex sets the price for the two groups.

  • First the Youngsters: Click the [Youngsters Demand] button to reveal the demand curve and the corresponding marginal revenue curve for movie patrons between the ages of 13 and 18. The relatively steep demand curve indicates a relatively low elasticity. This group is not very sensitive to price.

    The Cineramaplex maximizes profit from this group by equating marginal revenue and marginal cost, then charging the corresponding price that the youngsters are willing to pay. Click the [Youngsters Price] to reveal this profit-maximizing solution. The priced charged the youngsters is $9 per ticket.


  • Next the Oldsters: Click the [Oldsters Demand] button to reveal the demand curve and the corresponding marginal revenue curve for movie patrons over the age of 50. The relatively flat demand curve indicates a relatively high elasticity. This group is very sensitive to price.

    The Cineramaplex maximizes profit from this group by equating marginal revenue and marginal cost, then charging the corresponding price that the oldsters are willing to pay. Click the [Oldsters Price] to reveal this profit-maximizing solution. The priced charged the oldsters is $5.85 per ticket.

The obvious conclusion from this analysis is that the price charged to each group is different. The oldsters with the more elastic demand are charged a lower price and the youngsters with the less elastic demand are charged a higher price. This, of course, is possible because the two groups have different price elasticities of demand. If the two groups have the same elasticity, then they are charged the same price.

If the Cineramaplex can identify other groups, each with a different price elasticity of demand, each that can be separated by an easily identifiable characteristics (gender, height, hair color), then it can extend this price discrimination... and in all likelihood increase its profit.

<= PRICE CHANGE, UTILITY ANALYSISPRICE ELASTICITY OF DEMAND =>


Recommended Citation:

PRICE DISCRIMINATION, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: January 21, 2018].


Check Out These Related Terms...

     | first-degree price discrimination | second-degree price discrimination | third-degree price discrimination |


Or For A Little Background...

     | monopoly | market control | perfect competition | price elasticity of demand | consumer surplus | demand | demand curve | marginal revenue | marginal revenue curve | marginal cost | marginal cost curve | profit maximization |


And For Further Study...

     | perfect competition, profit maximization | monopoly, profit maximization |


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