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April 19, 2014 

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IMPORT SUBSTITUTION: A strategy for economic development for a country based on replacing imported goods with domestic production. This is often directed toward imported inputs used for domestic production. The goal of this policy is to encourage domestic production, which subsequently increases domestic income and consumption. A contrasting economic development is export promotion.

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THIRD-DEGREE PRICE DISCRIMINATION:

A form of price discrimination in which a seller charges different prices to groups that are differentiated by an easily identifiable characteristic, such as location, age, sex, or ethnic group. This is the most common type of price discrimination. This is one of three price discrimination degrees. The others are first-degree price discrimination and second-degree price discrimination.
Third-degree price discrimination occurs if a seller charges different prices to two or more different buying groups with different demand elasticities. These groups can then be differentiated based on characteristics such as, age, location, or sex. Examples of third-degree price discrimination abound throughout the economy. The plethora of children and senior citizen discounts offers a large contingent of examples. Children, or better yet, families with small children tend to have lower demand elasticities for goods such as eating at restaurants and staying at motels than others.

Three Conditions

To be a successful price discriminator, a seller must satisfy three conditions: (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.

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

Two Groups, Two Prices

Third-degree price discrimination can be illustrated using this exhibit. The hypothetical firm used for this example is the 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. The two groups are:

  • Youthful movie patrons, those in the 13-18 year age group, are not very responsive to ticket prices. In other words, they have a less elastic demand and will 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 admit youthful individuals. Oldsters can be charged another price and given tickets that only admit elderly individuals. Tickets cannot be traded between the groups because only those with the proper aged-based tickets are allowed entry into the Cineramaplex.

Third-Degree
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 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 price 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 price 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. 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.

The Other Two Degrees

Third-degree price discrimination is one of three forms of price discrimination. The other two are first-degree and second-degree.
  • 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.

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Recommended Citation:

THIRD-DEGREE PRICE DISCRIMINATION, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2014. [Accessed: April 19, 2014].


Check Out These Related Terms...

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


Or For A Little Background...

     | monopoly | market control | perfect competition | price elasticity of demand | consumer surplus | demand | demand curve | demand price | 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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