How Do Companies Use Price Discrimination?

Price discrimination is a strategy where companies charge different prices to different customers for the same goods or services. Price discrimination is most valuable when separating the customer markets is more profitable than keeping the markets combined.

  • Price discrimination is the practice of targeting different consumers with different prices.
  • This allows companies to offer lower prices to the most sensitive consumers while charging higher prices to those with more spending power.
  • There are three degrees of price discrimination, based on what type of information is available.
  • Student and senior discounts are a familiar form of age-based price discrimination. In addition, many companies offer lower prices according to geographical variations in income.

Understanding Price Discrimination

Companies use price discrimination to target consumers who cannot otherwise afford their products, without losing revenue from those customers who can afford to pay full price. The most familiar form of price discrimination is in the form of student and senior discounts: because of their comparatively low income level, these consumers are targeted with lower prices.

Price discrimination is often practiced alongside market segmentation, where the different categories of buyers can be clearly distinguished. Each segment is then targeted with a different pricing strategy. Some companies may segregate buyers geographically, offering lower prices in neighborhoods with a lower average income. Others may use mailers or coupons targeted at the most price-sensitive consumers.

There are three degrees of price discrimination. Companies use these types of price discrimination to determine the prices to charge different consumers.

First-Degree Price Discrimination

First-degree price discrimination is when companies attempt to charge each consumer the maximum amount that they are willing to pay. For companies to use this strategy, they must know what their consumers are willing to pay for their product.

A familiar form of first-degree discrimination occurs in subscription services, such as internet and cable services. After an initial one-year period, the service provider may automatically renew the contract at a higher monthly rate. Customers who object to the higher price may be offered a discount to keep the service, while those who do not complain continue paying the higher price.

Second-Degree Price Discrimination

Second-degree price discrimination is used to provide better prices for bulk or bundled purchases. Unlike first-degree discrimination, this does not require extensive knowledge of a buyer's income or shopping habits.

If you've ever received a coupon or special offer for lower prices, you may have been the subject of price discrimination.

For example, companies may offer special bulk discounts for large purchases, allowing them to increase their total revenues but decrease their per-unit profits. 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.

What Is Price Discrimination in Simple Words?

Price discrimination is when companies offer different prices to different groups of consumers, in order to maximize their revenue. For example, a company might charge a high price for a certain product, but offer the same product at a discount to students or lower-income customers.

Why Do Companies Practice Price Discrimination?

Companies practice price discrimination in order to maximize profits. Since a large market typically includes many types of consumers, price discrimination allows companies to offer a high price to well-off consumers and a low price to the most price-sensitive consumers.

What Is an Example of Price Discrimination?

A familiar form of price discrimination comes in the form of student and senior discounts. Because these groups tend to have lower income, they are unlikely to be able to afford full price for discretionary purchases such as movie and concert tickets. By offering a lower price to these groups, companies can expand their customer base without reducing the prices charged to the largest group of customers.

Is Price Discrimination Illegal?

Price discrimination is not illegal in the United States, unless it targets a protected class such as race, gender identity, national origin or disability status. For example, a company that offers higher prices to members of one ethnic group would likely be guilty of illegal discrimination. However, it could be permissible for a company with several stores to offer higher prices in an affluent neighborhood and lower prices in a lower-income district.

What Are the Types of Price Discrimination?

There are three degrees of price discrimination, depending on the amount of information needed about the customer. First-degree price discrimination seeks to charge each consumer's the maximum amount that they are willing to pay. This usually requires extensive knowledge about each customer's buying and shopping habits.

Second-degree price discrimination does not require any special knowledge, and instead is based on volume. Consumers are offered lower prices for bulk, bundled, or frequent purchases. Third-degree price discrimination offers different prices to different market segments. Companies may offer discounts based on age, geographical considerations, or income.