Cambridge International as and a level Economics Ebook

Price discrimination
Price discrimination was briefl y mentioned in the 
context of a monopolist. It can, however, be used by 
any fi rm to increase its profi ts by reducing consumer 
surplus and converting this into producer surplus. 
Th
e only exception is in perfect competition. To 
price discriminate, the fi rm must have some control 
over price; in other words, its demand curve must be 
downward-sloping.
Th
ere are three recognised types of price discrimination. 
Th
ey are:
■
First degree: This is a situation where the firm sells each 
unit of a product to a diff erent consumer, charging each the 
price (ideally the maximum) that they are willing to pay. In 
practice this is diff icult. Most examples are in the service 
sector. A private doctor may charge each patient what he 
feels that person can aff ord to pay. If he is feeling kind, 
then richer patients might be charged more than those on 
low incomes. A car dealer is likely to weigh up just what a 
potential customer might be willing to pay for a second-
hand car, as might an estate agent selling a property. In 
each case the price is unique to that transaction. There is 
also no immediate chance of a resale. The demand curve 
in all such cases is the same as the marginal revenue 
curve; this indicates that the marginal revenue is equal to 
the price.
■
Second degree: This type of price discrimination is where 
consumers are only willing to purchase more of a product if 
price falls as more and more units are bought. This means 
that a higher price is charged for the first unit followed by 
a lower price as successive units are purchased. A type 
of discounting takes place as the quantity purchased 
increases. A good example is where progressive discounts 
are off ered as more is purchased. This oft en occurs with 
certain food items, car tyres or season tickets to watch a 
Premier League football team in the UK. The consumer 
benefits as does the firm whose output, total revenue and 
profits can be expected to increase.
■
Third degree: This is the most common form of price 
discrimination. It requires firms to actively discriminate 
between consumers and is based on the presumption 
that groups of consumers have a diff erent price elasticity 
of demand for the product. So, where consumers have a 
low inelastic demand, this demand is not price sensitive. 
They need the product and can be expected to pay a 
higher price for it than consumers whose demand is more 
price elastic. A good example is with air fares – flights 
booked earlier have a lower price than those booked 
closer to departure. Rail travel in many countries is 
priced on a peak and off -peak basis, whereby commuters 
travelling in the peak time slots pay higher fares than off -
peak leisure travellers, for whom price is more important. 
Another interesting case is where students may be given 
a discount at a food stall or the cinema. The overall 
outcome here is not entirely predictable. The firm’s 
revenue and profits should increase, otherwise there 
is no point in discriminating. The problem is that some 
consumer groups benefit yet others do not because of 
the higher prices they have to pay.
It may be possible for a monopolist to use price 
discrimination to produce at a profi t when competitive 
fi rms or a monopoly charging a single price could not 
cover costs. 
Figure 7.26
shows that at the single price 
profi t maximisation output, the total revenue would be 
3 × 40 
=
120 and the total cost would be 3 × 45 
=
135, 
giving a loss of 15. If the output was sold separately for 
what consumers would pay for each individual unit, 
the revenue would be 60 
+
50 
+
40 
=
150, giving an 
abnormal profi t of 15. Th
e monopolist has eff ectively 
tapped into the consumer surplus and turned it into 
producer surplus or profi t. If triangle A in the diagram