How Do Companies Benefit From Price Discrimination?

Price discrimination is the act of selling products at different prices to different customers to maximize sales. Companies benefit from price discrimination because it can entice consumers to purchase larger quantities of their products or it can motivate otherwise uninterested consumer groups to purchase products or services. While price discrimination is the act of charging different prices for the same good, there are different price discrimination strategies that can benefit a company.

Types of Price Discrimination

The first type of price discrimination is first-degree price discrimination, in which a different price is charged for every good. This means that a company can charge the maximum price for each unit, allowing it to capture the available consumer surplus. This type of discrimination is the least common.

Key Takeaways

  • Price discrimination happens when a seller charges different prices on goods to different customers, with the goal of maximizing profits.
  • There are three types of price discrimination.
  • Also known as perfect price discrimination, first-degree discrimination involves charging different prices for every product sold.
  • Second-degree discrimination is the process of selling products based on quantity discounts.
  • Offering senior discounts is an example of third-degree discrimination because different prices are charged to different people for the same product.

The second type of price discrimination is second-degree price discrimination, where different prices are charged based on the quantity of the goods purchased. With this type of discrimination, companies can encourage consumers to purchase large quantities by offering quantity discounts.

Finally, third-degree price discrimination happens when different prices are charged to different consumer groups for the same good. This type of discrimination helps companies capture consumer purchases from consumer groups that would otherwise be uninterested in their goods.

Necessary Conditions for Price Discrimination

Price discrimination is rarely possible unless certain market conditions are met:

  1. Different market segments, such as retail users and institutional users, must exist.
  2. Market segments must be kept separate by factors such as time, distance, or how they use the product.
  3. Different segments must be motivated by different prices.
  4. There must be no "seepage" between two markets, which means that a buyer cannot purchase in one market at one price and sell in another at a higher price.
  5. The firm must not be subject to price competition and have some monopoly power.  

Price Discrimination Examples

First-degree discrimination might involve some negotiating or "haggling" over price. Car sales at a dealership are an example. Customers rarely expect to pay the sticker price and many variables that eventually determine the final purchase price. A scalper of concert tickets or sellers of produce at a market might also use a first-degree discrimination approach to maximize sales.

Costco is a good example of second-degree price discrimination because it offers discounts for bulk purchases. Buy-one-get-one retail sales strategies are also an example of second-degree price discrimination, where the price of the average good is reduced when more goods are purchased.

Offering senior discounts at restaurants and movie theaters are typical examples of third-degree price discrimination. The products being sold are the same, but specific consumers are charged different prices and the goal is to generate revenues from a demographic that might otherwise not purchase the product.