Three Conditions

• 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.


• 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 ineffective if trade among groups is possible. Those buyers charged a higher price could simply purchase the good from those who purchase it at a lower price.

Blocks of Prices

This form of discrimination is made easier (and is somewhat legitimized) because price is based on the quantity sold, NOT the characteristics of the group. But the price differences reflect different demand elasticities of the different groups.

Second-Degree Price Discrimination

Second-degree price discrimination can be illustrated using the accompanying diagram. The demand curve displayed here is that facing Feet-First Pharmaceutical, a well-known monopolist that controls the market for Amblathan-Plus, the only cure for the deadly (but hypothetical) foot ailment known as amblathanitis.

On the surface, this appears to be a normal, run-of-the-mill, negatively sloped market demand curve. And it is. But behind the scenes are three different groups, each willing and able to pay different prices. The first group buys between 0 and 1 ounces of Amblathan-Plus, the second between 5 and 6 ounces and the third between 10 and 11 ounces.

This demand curve indicates that buyers are willing and able to pay a price in the range $10 for 0 to 1 ounces. Click the [Group 1] button to highlight. However, based on the law of demand, buyers are willing and able to pay something more like $7.50 for 5 to 6 ounce range. Click the [Group 2] button to highlight. And for the vicinity of 10 to 11 onces, buyers are willing and able to pay about $5. Click the [Group 3] button to highlight.

As such, second-degree discrimination results if the monopoly establishes "block pricing." Any buyer purchasing up to 1 ounce, pays a price of $10 per ounce. Any buyer purchasing up to over 5 ounces, pays a price of $7.50 per ounce. And any buyer purchasing over 10 ounces, pays a price of $5 per ounce.

The seller might be able to justify this based on decreasing average cost or economies of scale, which enables "volume discounts." However, the likely reason is that each quantity range differentiates different groups of buyers each with a different price elasticity of demand. The low price/large quantity group pays a lower price than the high price/small quantity group because it has a lower price elasticity of demand.

The Other Two 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.


• 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 on highways is another.