Price discrimination happens when an organization or firm considers different price strategies for the same or identical goods to different groups of customers. This customer groupism based upon on certain attributes and accordingly they charge different price. For an example, Mercedez-Benz when it introduced 190 Sedan in the United States of America, it was sold for $26000 compared to West Germany where it was sold for $12000. Pharmaceutical companies fix different rates for the same drug in different countries. Senior citizens are offered lower fares in bus and movie theatres.
These are a few common examples for price discrimination. 2. Conditions necessary for profitable price discrimination: A firm’s profit rises significantly by adopting price discrimination. To practice price discrimination profitably three conditions must be satisfied. ? The firm should be a price maker: Let us suppose the supplier of the good is a price taker. In such a case, all the consumers would pay the same price for the supplier’s goods. Charging different prices to different customers would be of no value and so the best they can do is charge everyone their common willingness.
But if a price maker foolows this strategy he would face a download sloping demand curve. So he would follow the price discrimination strategy. ? The firm must classify which consumer is which: Suppose a person owns a restaurant, he would be sure that some diners will like to pay more than others. But it is impossible to find out any individual’s willingness to pay. In such a situation practising price discrimination will become difficult. For this reason most restaurants charge the same price for everyone. Sometimes partial identification is possible. For example, in a bar woman would be willing to pay less than a man.
The scheme will fail if customers purchase at lower prices and sell it to customers who are charged higher. Such customers are said to be engaged in arbitrage. So if everyone practices this, then price discrimination will become ineffective. ? “Consumers must not be able to engage in arbitrage” For example, some European manufacturers and Mercedez-Benz have demanded U. S. Congressional action freeze automobile consumers from going to Europe, where they buy at lower prices and transport it to America and resale it. There are three different types of price discrimination. . First Degree Price Discrimination: “Under first degree price discrimination, also known as perfect price discrimination, the firm is able to sell each unit of output at a price just equal to the buyer’s maximal willingness to pay for that unit”. In figure, the consumer would be willing to pay P1 for the first unit of goods he buys, P2 for the second and so on. This charge for the successive units is fixed by the firm. By following this perfect price discrimination the firm achieves maximum revenue enhancement and also gains control of all the consumer surplus.
To capture this consumer surplus, the firm should know the demand curve of each buyer. For example, assume the haggling between a consumer and anew car dealer. The sales person has to capture the customer’s willingness to pay and have to decide accordingly whether to quote him the sticker price or cut down below the list price and eat into his profit margin. Getting to know this consumer demand is so costly that it actually restricts them from practicing first degree discrimination. Price | | | | | |P1 | | | | | |P2 | | | | | |P3 |Block 1 |Block 2 |Block 3 | | |0 | |Q1 |Q2 |Q3 Quantity per | | | | | |period |
In other words we can explain this as, price is fixed depending on the quantity of goods purchased by the consumer. Each of the customer then depending on where there is maximum consumer surplus, falls into a block or category. The firm does not have the information to categorise a customer to a particular group. So they need to make some complicated strategies if a customer switches from one block to another when the price in the nearby block is changed.
For example, if the firm increased P3, then the consumer who purchases larger quantity for lower price will decide to purchase quantity below Q2 because of the minimization in consumer surplus. So in this discrimination the firm is unable to adjust to consumer surplus. For an example, professional journals charge higher price for libraries than to individual subscribers. For third degree price discrimination, the buyer will be divided into two categories, individuals and libraries.
The journals suppliers can separate the libraries by their address, and so libraries can’t make them believe as they are individual subscribers. In comparison, the second degree discrimination can’t categorize consumers based on a group. Another example which illustrates second degree discrimination i. e where the price depends on the quantity purchased is buying monthly public transit pass, which costs less then buying individual tickets per ride. Nevertheless, it also depends upon the consumers cost saving purpose also to go for quantity discounts. . Third Degree price discrimination: In this discrimination the firm knows from their experience that consumers of different groups have different tastes and demands. The price maker uses reliable strategies to break up the customers into groups. Then to make profit they choose different pricing strategies to different groups. By doing so they make sure that consumers in the higher price category can’t purchase goods in lower-priced market. http://web. ebscohost. com/ehost/pdf? vid=1&hid=7&sid=b64c5149-fbc3-4035-89b2-82529791fdcc%40sessionmgr9 6.
Price strategies and compatibility in digital networks Firms are using personalization technologies which allow them to use various product and price customization strategies. The usage of such technologies they are able to get customer-specific information, and thereby allow them to use first degree discrimination. Mobile providers are switching from 2G to 3G mobile systems. Customer specific information is more accurate while using 3G in comparison to 2G. The usage of these technologies is very much higher in digital communication networks for example cellular networks.
For them to use price discrimination it completely depends upon the technology they are using. For example let us consider 3G mobile like UMTS. For consumers who access network from home, 3G-provider faces competition from fixed line providers. They charge the customers low prices when they are using the mobile phone from their homes and charge higher when they are using outside the home. Therefore they have got advantage over fixed line providers over mobility and customers are hence not hesitant to go for 3G and pay higher prices for mobility.
Because these new technologies are giving them an opportunity to implement price discrimination, the question is how price strategies affect the motivation to independently set up a walled garden where the rival’s consumers have imperfect right of entry. We are comparing the competition between two horizontally differentiated companies in terms of network effects. Walled garden strategy is more possible when firms use price discrimination than when they are using linear pricing. Farrell and Saloner(1992) show that when degree of compatibility is imperfect market share matters.
Now let us see the difference with respect to pricing and compatibility between voice mails and text messages in the mobile market. Price discrimination is widely used for mobile voice calls. The price per minute vary for high and low end tariffs. Also in the Europe the mobile charge is high for off net calls. On the other hand the price of the text message is not depended upon the type of subscription we are using and also not depended on whether it is off net or on net. But still, some providers have started using price discrimination for text messages also.
So in the end both the firms may use price discrimination but also their profit margins will also be higher than when they are using linear pricing. We will now assume the linear transportation cost. The first degree price discrimination becomes more gainful when transportation costs turn into more convex. Let us assume the transportation cost t(x)=tx n where n >=1 and n is an integer value. So profit is more when there is price discrimination than when n is higher than a critical value. So when transportation costs rise fast, the customers who are locked in are one who is staying close to he provider. The providers are able to pull out surplus from these locked in customers using first degree price discrimination. Moreover the market sharing becomes robust when transportation costs are increasing fast. 7. Recommendation: After analysing two horizontally differentiated network providers, the firm using price discrimination will use walled garden strategy more often. Recent personalization technologies have allowed them to do price differentiation to different types of customers. Hence switching from 2G to 3G has made them use price discrimination.
And in comparison to 3G, 2G will have to reduce the cost in a larger area. They will have to come up with some new technologies so that they can price discriminate between their customers. Conclusion: After analysing we can come to a conclusion that price discrimination should be used in the firms. This is because there are customers with different tastes of buying a product. Some of the customers would like to purchase in huge volumes but some of the customers may go vice versa. It is the firm’s strategy to make buyers buy their product in huge sum or in small quantities.
Some of the firms would like to target both of these buyer groups and will fix the price of the product, because ultimately they would look for a profit margin. Price discrimination is also a ploy of the firm’s to attract customers. By deploying such price discrimination they are actually doing a type of promotion of their product which can attract the customers. Some times the firm’s are able to meet the customer’s surplus which the customers are eagerly looking for. This would also in fact help their product value to reach a larger people or customers.