CLASSIFICATION OF PRICE DISCRIMINATION BY DEGREE Price Discrimination

CLASSIFICATION OF PRICE DISCRIMINATION BY DEGREE Price Discrimination can be classified into 3 types namely; n. First Degree price discrimination n. Second degree price discrimination n. Third degree price discrimination

FIRST DEGREE PRICE DISCRIMINATION n This is the most profitable and least likely form of price discrimination. n It is the charging of a different price for each unit of output. The prices charged are the reservation or maximum prices. n Here the first degree/perfect price discriminator is able to charge a different prices for each unit of output by selling each unit of output separately to the highest bidder or to every consumer at its exact reservation price.

FIRST DEGREE PRICE DISCRIMINATION- CONTINUED n In other words, the supplier sells that unit of output at the highest price that buyers are willing to pay for that unit of output instead of doing without it. n This implies that under 1 st degree price discrimination, no consumer surplus is left as every consumer pays the maximum amount he/she is willing to commit for the good in question.

FIRST DEGREE PRICE DISCRIMINATION- CONTINUED n Recall that, consumer surplus is the difference between what the consumer would have paid for a particular quantity of a commodity rather than do without it and the price he actually pays. n Basically, perfect price discrimination allows the monopolist to extract every bit of consumer surplus from each buyer. Here all consumer surplus is appropriated as producer surplus.

FIRST DEGREE PRICE DISCRIMINATION- CONTINUED n Here we find that the monopolist is able to charge the maximum price for each unit sold. This total revenue is P 1+P 2+P 3+…P 11 n The shaded area represents consumer surplus prior to the instigation of price discrimination and this is transformed to the monopolist and becomes monopoly rent after price discrimination

FIRST DEGREE PRICE DISCRIMINATION- CONTINUED Example You visit a jewelling shop where you are faced with the choice of take it or leave it. (i. e. fixed price). n If the seller of the jewelry can figure out exactly the shape of your demand curve, he would be in the position to know how much you will be willing to pay than do without the jewelry. n The seller will then charge you a price that will leave you with no consumer surplus. n You will then be a ‘victim’ of perfect price discrimination. n

2 ND DEGREE PRICE DISCRIMINATION n This is a cruder type of price discrimination as compared to the perfect/1 st degree price discrimination. n Here the supplier divides output into successive batches and sells each batch for the highest price that buyers are willing to pay for that output. n This type occurs more often when there are many buyers within the market and provided that the typical buyer purchases several units of the product.

SECOND DEGREE PRICE DISCRIMINATION-CONTINUED In such a situation, the monopolist is not able to charge the maximum price for each unit sold. n Each block of units is sold at the maximum price and with a downward sloping demand curve, each successive block of unit will be sold at a lower price to the same buyer. n In fact, 2 nd degree price discrimination induces greater consumption by offering quantity discounts that are made in a stepladder fashion. It is also called multipart pricing. n

SECOND DEGREE PRICE DISCRIMINATION-CONTINUED Here the monopolist is not able to charge the maximum price for that unit sold. If it sells Q 8 and they are in blocks of 4, then it will charge P 4 for Q 4, and P 8 for (Q 8 -Q 4) block units. Thus total revenue equals P 4 Q 4 + P 8 Q 8 n The amount of consumer surplus extracted by the monopolist is equal to the shaded area and this is smaller than the consumer surplus extracted under 1 st degree price discriminator. n However profits obtained under 2 nd degree are greater than those obtained by the nondiscriminating monopolist who charges a pure monopoly price of Pm and sell a quantity of Qm. n

SECOND DEGREE PRICE DISCRIMINATION-CONTINUED Example n ‘Quantity discounts’ n Utilities charging lower prices for each additional block of units used. i. e. one can always buy the next block of unit at a lower price.

3 RD DEGREE PRICE DISCRIMINATION n This is the most common form of price discrimination. This form occurs when a monopolist charges different prices in different markets for the same product. n The general case we have already illustrated under the profit maximizing decision is about 3 rd degree. n Here a higher price is charged in the market with less elastic demand vice versa.

THIRD DEGREE PRICE DISCRIMINATION- CONTINUED Examples: n Charging students a lower price than nonstudents for movies, magazines professional journals etc. n Charging senior citizens a lower price than others for transportation and spectator events.

PRICE DISCRIMINATION- SUMMARY TYPE 3 rd Degree ATTRIBUTE EXAMPLES Different class of buyers, charge different prices for same product Students and Senior citizens charges on 2 nd Degree Declining rate schedule. i. e. lower prices charged per unit as larger quantities are purchased Electricity pricing, quantity discounts at supermarkets and retail cartels. 1 st Degree (Perfect) Each buyer charged exactly the price he will be willing to pay which leaves him indifferent between buying and not buying. Jewelry sales, haggling over prices of movies etc. souvenirs on tourist trips.