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How to Increase Profit through Price Discrimination in Managerial Economics

Price discrimination refers to a business situation where the same good is sold to different groups of consumers for different prices. For example, the couple sitting next to you at the movie paid a lower price to get in because they’re senior citizens. Or, perhaps you get a student discount at a local restaurant that non-students don’t get.

Price discrimination exists in a variety of situations. Therefore, economists define different degrees of price discrimination to reflect the various situations associated with this pricing policy. However, no significance is attached to whether or not price discrimination is of the first degree or third degree — one isn’t more important than the other.

Conditions necessary for price discrimination

Price discrimination requires the following conditions

  • You can segment the market into customers who have different price elasticities of demand.

  • The firm possesses some degree of monopoly power and can set price.

  • Finally, customers can’t resell the good. If customers are able to resell the good, those who pay a lower price can buy the good and sell it for a higher price, but not as high as the firm charges, to customers willing to pay the high price. This process is called arbitrage, and it limits the firm’s ability to benefit from price discrimination.

Price discrimination’s impact

Firms that engage in price discrimination generally

  • Produce a greater quantity of output. Because the firm is able to charge different prices to different groups of consumers, it can attract more buyers who are willing to pay a low price without sacrificing revenue from buyers willing to pay a higher price. By selling to both groups at different prices the firm increases the quantity of the good it sells.

  • Increase their profit. By charging different prices, the firm is able to capture more consumer surplus — the difference between the price a consumer is willing to pay and the price the consumer actually pays. This additional consumer surplus adds to the firm’s producer surplus.

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