Price discrimination is a strategy that companies use to charge different prices for the same goods or services to different customers. Price discrimination is most valuable when separating the customer markets is more profitable than keeping the markets combined.
The three main types of price discrimination are first degree, second degree and third degree. Companies use these types of price discrimination to determine the prices to charge different consumers.
First-Degree Price Discrimination
Companies use first-degree price discrimination to sell a product for the maximum price a consumer will pay. For companies to use this strategy, they must know what their consumers are willing to pay for a good.
For example, car dealers may exercise first-degree price discrimination by looking at how a potential car buyer is dressed. A consumer who has the latest version of a cellphone and wears expensive clothes is more likely to be able to pay a premium for a new car.
Second-Degree Price Discrimination
Companies practice second-degree price discrimination by charging different prices based on the quantity demanded. Companies generally offer special prices for consumers who buy in bulk.
For example, communications companies may offer special bulk discounts for buying a variety of their products. Many communications companies offer a packaged deal for internet, phone and television services at a discount to what consumers would pay for all three services separately.
Third-Degree Price Discrimination
Companies can also engage in third-degree price discrimination by offering different prices for different groups. Some companies may use age to discriminate among consumers and charge different age groups different prices.
For example, students and senior citizens may be given discounts because they exhibit high price sensitivity.