Understanding the 3 Types of Price Discrimination With Examples

3 types of price discrimination
Price discrimination can be referred to as ‘charging different prices for the same goods or services’. Typically, it is carried out to extract maximum possible surplus from the market and also to increase the volume of sales. Inaugural discounts, concessions on volume, special schemes, etc., are nothing but examples of price discrimination.

Broadly speaking, there are 3 types of price discrimination: First-degree, Second-degree, and Third-degree. Out of these, the third-degree discrimination is more frequently observed/encountered than the others. Nevertheless, there is a limit to such price discrimination, beyond which it can be considered as unhealthy and unethical enough to affect the consumers and, ultimately, the economy. The government, through various mechanisms, tries to restrict such practices.

While, theoretically, we all have encountered such types of price discrimination in our day-to-day lives, let’s delve deeper into the different types with elaborate examples and the economic terms attributed to them.

Types of Price Discrimination

First-degree/Perfect Price Discrimination

Features:

1. The seller can accurately collect information about the consumer―his background, economic class, geographic location, individual preferences, etc.

2. The seller has complete knowledge of the highest price the consumer is willing to pay.

3. The seller enjoys some degree of monopoly in the market.

After gaining information about the customer, the seller sells the product to the highest bid that the consumer is willing to offer. In this way, the firm eats up all the consumer surplus. However, this method of price discrimination is rarely seen, since, it is not possible to collect accurate and authentic information of the consumer. Besides, the seller must be able to enjoy monopoly in the market. Also, the transaction costs involved in gaining information about the customer must be compared with the profits gained by implementing such type of price discrimination. However, we can see in a few examples that it is possible to employ such kind of price discrimination where the seller negotiates for the highest bid. The seller will charge different rates for every unit consumed.

Examples:

Example #1: An ‘Auction’ is said to be an example of first-degree price discrimination. The bidder takes the information of the highest price which they are willing to pay, from the consumer, and accordingly, sells the product to the highest bidder.

Example #2: A practicing lawyer will first gather information from the client about his case, its related background, and then, accordingly charge fees for the same.

Second-degree Discrimination

Features:

1. This type involves charging different prices for different quantities sold.

2. Mostly, these price incentives are offered to encourage consumers to buy more. However, unlike first-degree discrimination, the seller does not have to gather information about his buyers.

3. The seller can charge homogeneous prices for all consumers or a particular group of consumers. With purchase of larger quantities, the prices are reduced.

4. The seller can also target a particular group of people by ‘block pricing’.

5. The seller cannot distinguish his buyers, hence, he offers sorted price ranges for every set of demand. However, he will not be able to extract all the consumer surplus, like first-degree discrimination. But, it is more practical and common than first-degree discrimination.

Examples:

Example #1: A classic example is electrical power cost. Households are charged a lesser price per unit power consumed, simply because they consume lesser power than commercial users.

Example #2: Quantity discounts offered at super markets―they offer discounts to consumers on quantity―to encourage bulk purchases. Don’t we all pick up goods in bulk just to avail heavy discounts on bulk purchases?

Example #3: Various industries charge different rates at various time periods―a very common phenomenon in the entertainment and transport industry. Commercial airlines, sometimes, offer concessions for early booking, or movie tickets are costlier on weekends and holidays than other days.

Third-degree Discrimination

Features:

1. This is the most common type of price discrimination, that we come across in our daily lives. In this type, the seller simply charges different prices to different sets of consumers, after distinguishing them on the basis of their age, gender, location, occupation, or any other special characteristic.

2. Their demand must be elastic and the markets must be classifiable into various segments.

3. The seller must be able to prevent ‘resale’ of his products―there must be no selling between two markets―where he sells at a lesser price, and the buyers sell them at higher price to others.

Examples:

Example #1: Discrimination on the basis of age.

– Travel concessions for senior citizens in public transport
– Recreational places, such as amusement parks, zoos, etc., where kids are charged lesser prices.

Example #2: Discrimination on the basis of gender.

– Hair/Nail Salons: Some salons charge different prices for men and women (for instance, haircuts, where it can be argued that women having longer hair than men, and require more styling)
– In some nations, where women are deprived of education, concessions are provided to encourage them to continue their education.
– Some bars sponsor ‘ladies night’; where beverages are sold at discounts or free of cost, to women only.

However, many are of the opinion that such kind of price discrimination on the basis of gender is biased and sexist in nature.

Example #3: Discrimination on the basis of occupation.

– Canteen concessions to staff, free parking facilities, etc.
– Some nations offer concessions to defense personnel, such as concessional medical facilities, education to their children, etc.

Example #4: Discrimination on the basis of quality of service/facilities.

– Different prices charged for the business and economy class by commercial airlines
– Hospitality and hotel industry charges different tariff according to the facilities provided―air-conditioning, number of beds, etc. Luxury and elite rooms are charged higher than the normal rooms.

Something to Ponder!

Today, the online shopping world is growing by leaps and bounds. Sitting in the comfort of your home, you can shop almost anything, anywhere! In the virtual world, the buyer and seller do not meet, and the distance is just a click away. However, that does not mean the virtual marketplace is devoid of price discrimination!

Online sellers display different prices on the basis of location, competition in the market, demand, related costs etc., with the use of software tools available today. Sellers try to analyze how much they can charge a consumer, on the basis of various criteria (as explained in first-degree price discrimination). Of course, these are estimates, and prone to errors.

Whether such kind of price discrimination is healthy is a question of debate. Pricing must adhere to statutory requirements, yet, with the growing Internet market, such kind of pricing policies no longer remain a surprise.

A good advice to consumers would be to be aware of the market prices and compare them with other markets too. Nonetheless, it would always be beneficial to do some research and make a wise and informed decision.

What is Price Gouging?

The simple and straight definition of this concept is pricing and selling at a price level, that is substantially higher than the fair price level.

Price Fixation and Cost Fixation

The concept of market is made up 4 important factions. Firstly, there is the product or the commodity that is sold by the supplier/producer. Next, there is the supply, that is number of units that are supplied into the market. Third, there is the demand for the supplied commodity or unit, which is of course backed by the ability of the consumer to pay for the same. Last, there is the price of the product.

There are two basic ways in which price of any commodity is ascertained.

– Costing is the primary, or initial method with the help of which price is set. Costing is a technique where the price of the commodity/product is derived at the factory level. In such a case, cost of production plus overheads, plus taxes, plus transportation cost, plus profit margin, determine the cost of the commodity.
– Once this commodity enters the market, a certain demand for it gets generated. The basic rule of thumb that is observed is that more the demand, for lesser units, the more is the price of the commodity. The less the demand the lesser the price. The same principle works the other way round also. That is, the more the units supplied, the less is the cost, and the less the supply the greater is the price. This principle is known as the demand and supply analysis.

Now, based upon these two principles, the suppliers/producers can also manipulate and escalate, or even inflate, the price levels in an unethical manner. Here’s an explanation on how it is done, or why it is deemed to be unethical.

About Price Gouging

All of us have heard of gouging of gas price. In this phenomenon, the actual calculated cost price of gas is much lower, and the price for which it is sold is much higher. Now, the unethical part comes in where sellers, increase their profit margin, overprice their production cost and finally send lesser units into the market.

In such instances the price escalates, drastically, or unnaturally. A method which escalate the prices, which is commonly used, is where the number of units sent into the market is very less and at the same time, a substantial number of units that are sold are stored away, creating a higher demand, boosting the price levels. When the levels go up, the stored away units are sold off. This phenomenon is known as artificial scarcity.

The gouging phenomena comes under the scanner of governments, when the general public gets affected by it. Auctions, costly and luxury goods, cannot be deemed to have gouging effects. However, fuel, medicines, food, clothing and other things that are required to survive, or even live properly, cannot be priced over a certain limit. If the prices exceed the fair price, then anti-gouging policies are adopted by the government. Gouging of prices is a felony in some nations and states.

Gouging of prices is something that is to be frowned upon, as it is almost as good as robbing of basic needs. Socialist and communist nations deal with such phenomena in a very harsh manner. There are some basic necessities of every human being on which a price tag cannot be added on, simple things like water or air or medicines or even a few morsels of food, are not be sold or measured in monetary terms, they are to be shared properly, and justly by all humanity.