Price discrimination or yield management occurs when a firm charges a different price to different groups of consumers for an identical good or service, for reasons not associated with costs. It is important to stress that charging different prices for similar goods is not pure price discrimination. We must be careful to distinguish between price discrimination and product differentiation – differentiation of the product gives the supplier greater control over price and the potential to charge consumers a premium price because of actual or perceived differences in the quality / performance of a good or service. Conditions necessary for price discrimination to work Essentially there are two main conditions required for discriminatory pricing o Differences in price elasticity of demand between markets: There must be a different price elasticity of demand from each group of consumers. The firm is then able to charge a higher price to the group with a more price inelastic demand and a relatively lower price to the group with a more elastic demand. By adopting such a strategy, the firm can increase its total revenue and profits (i.e. Achieve a higher level of producer surplus). To profit maximise, the firm will seek to set marginal revenue = to marginal cost in each separate (segmented) market. O Barriers to prevent consumers switching from one supplier to another: The firm must be able to prevent “market seepage” or “consumer switching” – defined as a process whereby consumers who have purchased a good or service at a lower price are able to re-sell it to those consumers who would have normally paid the expensive price. This can be done in a number of ways, – and is probably easier to achieve with the provision of a unique service such as a haircut rather than with the exchange of tangible goods. Seepage might be prevented by selling a product to consumers at unique and different points in time – for example with the use of time specific airline tickets that cannot be resold under any circumstances. Examples of price discrimination Price discrimination is an extremely common type of pricing strategy operated by virtually every business with some discretionary pricing power. It is a classic part of price competition between firms seeking a market advantage or to protect an established market position. (a) Perfect Price Discrimination – charging whatever the market will bear Sometimes known as optimal pricing, with perfect price discrimination, the firm separates the whole market into each individual consumer and charges them the price they are willing and able to pay. If successful, the firm can extract all consumer surplus that lies beneath the demand curve and turn it into extra producer revenue (or producer surplus). This is impossible to achieve unless the firm knows every consumer’s preferences and, as a result, is unlikely to occur in the real world. The transactions costs involved in finding out through market research what each buyer is prepared to pay is the main block or barrier to a businesses engaging in this form of price discrimination. If the monopolist is able to perfectly segment the market, then the average revenue curve effectively becomes the marginal revenue curve for the firm. The monopolist will continue to see extra units as long as the extra revenue exceeds the marginal cost of production. The reality is that, although optimal pricing can and does take place in the real world, most suppliers and consumers prefer to work with price lists and price menus from which trade can take place rather than having to negotiate a price for each unit of a product bought and sold. Second Degree Price Discrimination This type of price discrimination involves businesses selling off packages of a product deemed to be surplus capacity at lower prices than the previously published/advertised price. Examples of this can often be found in the hotel and airline industries where spare rooms and seats are sold on a last minute standby basis. In these types of industry, the fixed costs of production are high. At the same time the marginal or variable costs are small and predictable. If there are unsold airline tickets or hotel rooms, it is often in the businesses best interest to offload any spare capacity at a discount prices, always providing that the cheaper price that adds to revenue at least covers the marginal cost of each unit. There is nearly always some supplementary profit to be made from this strategy. And, it can also be an effective way of securing additional market share within an oligopoly as the main suppliers’ battle for market dominance. Firms may be quite happy to accept a smaller profit margin if it means that they manage to steal an advantage on their rival firms. The expansion of e-commerce by both well established businesses and new entrants to online retailing has seen a further growth in second degree price discrimination.
The economic feasibility of price discrimination requires the fulfillment of following conditions.The price discrimination is possible in the presence of monopoly or like wise situation. Any firm working under comparative condition cannot differentiate between. S in the case of wapda has monopoly in the production and sale in the electricity is in position to charge different prices.
The success of PD attributed to an important condition known as necessary condition of PD. It states that elasticity of demand for the product monopolist must be different. The market where the demand where the monopolist product is more electricity he will charge a low price wile the market where the demand for the monopolist product is elastic he will charge a high price.
If the previous condition is accorded the necessary condition the sufficient condition that the monopolist must be capable enough to be keeping his market separate. Consumers should be not being able to purchase to commodity from the low price market and resell it in the high price market. Moreover the customers in the dearer market should not transfer themselves to the cheaper sector in order to benefits from the lower price.