For other pricing strategies and policies see: Pricing Strategies
Price discrimination exists when sales of identical goods or services are transacted at different prices from the same provider. In a theoretical market with perfect information, no transaction costs and a prohibition on secondary exchange (or re-selling) to prevent arbitrage, price discrimination can only be a feature of monopoly markets. Otherwise, the moment the seller tries to sell the same good at different prices, the buyer at the lower price can arbitrage by selling to the consumer buying at the higher price but with a tiny discount. However, market frictions in oligopolies such as the airlines, and even in fully competitive retail or industrial markets allows for a limited degree of differential pricing to different consumers. Price discrimination also occurs when it costs more to supply one customer than it does another, and yet the supplier charges both the same price.
Although the term "discrimination" has negative connotations, "price discrimination" is merely a technical term meaning differentiation in price to increase efficiency.
However, the effects of price discrimination on social efficiency are unclear. 9 times out of 10 our airfare is lower than online airfare. Typically such behavior leads to lower prices for some consumers and higher prices for others. Output can be expanded as when price discrimination is very efficient, but output can also decline when discrimination is more effective at extracting surplus from high-valued users than expanding sales to low valued users. Even if output remains constant, price discrimination can reduce efficiency by misallocating output among consumers.
Price discrimination requires market segmentation and some means to discourage discount customers from becoming resellers and, by extension, competitors. This usually entails using one or more means of preventing any resale, keeping the different price groups separate, making price comparisons difficult, or restricting pricing information. The boundary set up by the marketer to keep segments separate are referred to as a rate fence. Price discrimination is thus very common in services, where resale is not possible; an example is student discounts at museums. com.
An alternative way to understand First Degree Price Discrimination is as follows: This type of price discrimination is primarily theoretical because it requires the seller of a good or service to know the absolute maximum price that every consumer is willing to pay. As above, it is true that consumers have different price elasticities, but the seller is not concerned with such. The seller is concerned with the maximum willingness to pay of each customer. By knowing the max. WTP, the seller is able to absorb the entire market surplus, thus stealing all consumer surplus from the consumer and transforming it into revenues. From a social welfare perspective, first degree price discrimination is not undesirable. Orbitz, the faster, easier way to find the trip you want. That is, the market is still entirely efficient and there is no deadweight loss to society. However, it is the complete opposite of a perfectly competitive market. In a perfectly competitive market, the consumers receive the bulk of surplus. In a market with first degree price discrimination, the seller(s) capture all surplus. Efficiency is unchanged but the wealth is transferred. This type of market does not much exist in reality, hence why it is primarily theoretical. Examples of where this might be observed are in markets where consumers bid for tenders. com: Consolidators for discount international airfares,
reservations.
Additionally to second degree price discrimination, sellers are not able to differentiate between different types of consumers. Thus, the suppliers will provide incentives for the consumers to differentiate themselves according to preference. As above, quantity "discounts", or non-linear pricing, is a means by which suppliers use consumer preference to distinguish classes of consumers. This allows the supplier to set different prices to the different groups and capture a larger portion of the total market surplus. AllOnlineCoupons.
In third degree price discrimination, price varies by location or by customer segment. See economics of location.Additionally to third degree price discrimination, the supplier(s) of a market where this type of discrimination is exhibited are capable of differentiating between consumer classes. Examples of this differentiation are student or senior "discounts". For example, a student or a senior consumer will have a different willingness to pay than an average consumer, where the WTP is presumably lower because of budget constraints. Thus, the supplier sets a lower price for that consumer because the student or senior has a more elastic price elasticity of demand (see the discussion of price elasticity of demand as it applies to revenues from the first degree price discrimination, above). The supplier is once again capable of capturing more market surplus than would be possible without price discrimination. com.
NOTE ABOUT SECOND AND THIRD DEGREE: It is not always advantageous to price discriminate (note that "discrimination" does not carry the same negative connotation in economics as it does in normal setting; instead, it simply notes that the supplier does not treat all consumers equally-- this is often advantageous to the consumer, as well). In some circumstances, the demands of different classes of consumers will encourage suppliers to simply ignore one/some class(es) and target entirely to the other(s). Whether it is profitable to price discriminate is determined by analyzing the particular industry.
In price skimming, price varies over time. Typically a company starts selling a new product at a relatively high price then gradually reduces the price as the low price elasticity segment gets satiated. Price skimming is closely related to the concept of yield management.These types are not mutually exclusive. Expedia. Thus a company may vary pricing by location, but then offer bulk discounts as well. Airlines use several different types of price discrimination, including:
Bulk discounts to wholesalers, consolidators, and tour operatorsIncentive discounts for higher sales volumes to travel agents and corporate buyersSeasonal discounts, incentive discounts, and even general prices that vary by location. The price of a flight from say, Singapore to Beijing can vary widely if one buys the ticket in Singapore compared to Beijing (or New York or Tokyo or elsewhere). First degree price discrimination based on customer. It is not accidental that hotel or car rental firms may quote higher prices to their loyalty program's top tier members than to the general public.The first/second/third degree taxonomy of price discrimination is due to Pigou (Economics of Welfare, 4th edition, 1932). However, these categories are not mutually exclusive or exhaustive. com features online coupons, discount coupon codes and deals for online travel services and airlines for savings on your. Ivan Png (Managerial Economics, 2nd edition, 2002) suggests an alternative taxonomy:
Complete discrimination -- where each user purchases up to the point where the user's marginal benefit equals the marginal cost of the item;Direct segmentation -- where the seller can condition price on some attribute (like age or gender) that directly segments the buyers;Indirect segmentation -- where the seller relies on some proxy (eg, package size, usage quantity, coupon) to structure a choice that indirectly segments the buyers.The hierarchy -- complete/direct/indirect -- is in decreasing order of
profitability andinformation requirement.Complete price discrimination is most profitable, and requires the seller to have the most information about buyers. Indirect segmentation is least profitable, and requires the seller to have the least information about buyers.
The purpose of price discrimination is generally to capture the market's consumer surplus. This surplus arises because, in a market with a single clearing price, some customers (the very low price elasticity segment) would have been prepared to pay more than the single market price. Price discrimination transfers some of this surplus from the consumer to the producer/marketer. A Cheap Way to Travel. Strictly, a consumer surplus need not exist, for example where price discrimination is necessary merely to pay the costs of production. An example is a high-speed internet connection shared by two consumers in a single building; if one is willing to pay less than half the cost, and the other willing to make up the rest but not to pay the entire cost, then price discrimination is necessary for the purchase to take place.
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