Price Discrimination Essay, Research Paper
Price Discrimination
Prices are based upon the price elasticity of demand in each given
market. In other terms, this means that during ladies night at the local
bar, it costs more for men to have a beer than women simply because
these bars find it o.k. to charge females less, as a way to draw more
females to the business on a specific night. Price discrimination is part
of the commercial and business world. Movie theaters, magazines,
computer software companies, and thousands of other businesses have
discounted prices for students, children, or the elderly. One important
note though, is that price discrimination is only present when the exact
same product is sold to different people for different prices. First class
vs. coach in an airline (though sometimes just differing in how many
free drinks you can get) is not an example of price discrimination
because the two tickets, though comparable, are not identical. Price
discrimination is based upon the economic idea of marginal analysis.
This process deals specifically with the differences in revenue and costs
as choices and decisions are made. Profit maximization is achieved not
when the number of products sold is the highest, or when the price is
the highest. . Groups that are more sensitive to prices, (students and
senior citizens for example), have a lower price elasticity of demand and
are the ones that are often charged the lower prices for the identical
goods or services. The key to price discrimination and using it to fully
compliment other economic practices, ultimately achieving the total
profit maximization, is the ability to effectively and efficiently collect,
analyze, and act upon data gathered about the different groups. First
of all, the groups must be accurately identified and the differences
between groups must be thought of ahead of time. Children, genders,
and senior citizens are easily singled-out by appearance, while military
personnel, college students, and other groups must carry some sort of
identification. Firms typically will quote the highest prices in
advertisements, and then offer discounts to qualified groups. The three
basic conditions for price discrimination to be effective are: 1)
Consumers can be divided into and identified as groups with different
elasticities of demand. 2) The firm can easily and accurately identify
each customer. 3) There is not a significant resale market for the good
in question. The thought process behind the practice of first degree
price discrimination is that the firm has enough accurate information
about the consumer, and that products can be sold each time for the
maximum amount that the consumer is willing to pay. The two more
common examples of first-degree price discrimination is called “price
skimming” and “all-or-none offers”. Skimming refers to the demand
function, as firms take the top of the demand of a given good to
maximize profits on the sale. This, of course, requires that the firm
know the actual demand for the good that it produces. The firm must
divide its customers into distinct, independent groups based upon their
respective demands for the good. The firm wants to first sell to the
group who will pay the highest price for the new product. It then
reduces the cost slightly and sells to another group with only a slightly
less demand for the good. This process is copied on numerous occasions
until the marginal revenue drops to equal marginal cost. While this
example may seem similar to other examples of price discrimination,
you should remember that the most significant difference here is that
there are a virtually limitless number of possible prices that, if charges
correctly, will lead to profit maximization in the end. The firm must, of
course, be on the ball and must make constant changes of the demand,
and the price for the good, at any given time, after the initial price is
set, and a number of units are sold. Firms practicing price skimming
will generally start their pricing schedules where the demand schedule
has its vertical interception. From there, as the demand at any given
price shrinks, the firm readjusts the price of the good to get more sales.
As before, the firm maximizes profits where the marginal revenue is
equal to marginal cost. The firm will not continue to sell the good
below this point. The trick to price skimming is that the consumers do
not become accustomed to the process and therefore “wait” for the
prices to drop. Customers may be upset about paying a higher price
initially, and this may lead to the customer not becoming a return
customer next time, or simply that the customer who bought at a high
price this time will hold off on a purchase next time, waiting for a price
reduction. Price skimming is no longer effective if the consumers have
been conditioned to the process. The other example of first-degree price
discrimination is the “all-or-none” model. This means that the firm will
set a price for a given good, and no matter what portion of the good
you desire, you pay the same price as if you were to purchase all of
them. The diamond industry is an example of this, often selling
less-than-perfect gems along with the perfect gems in order to get rid of
the less-desirable merchandise. By putting goods together in a “grab
bag”, firms can rid themselves of merchandise that would normally not
sell otherwise, or at least not for the same price. Likewise, firms can sell
larger than necessary volumes of certain items, even though no one in
his or her right mind would willingly purchase such large quantities of
certain goods. This format of moving merchandise is especially popular
at auctions. A branch of price discrimination, second degree is the
practice of selling incremental amounts of a good for incremental
prices. For example, the first 12 pairs of shoes are $80, the next 12 pair
are $72, and so on. The 2nd degree often allows the firm to sell more
quantity than they would ordinarily. Customers with higher demand
prices will tend to buy smaller quantities at higher average unit prices,
while those with lower demand prices will more often purchase the
larger quantities at a lower unit cost. Second degree price
discrimination generally leads to a situation where more quantity per
unit is sold. Sam’s Club is the 2nd degree price discrimination heaven.
Mr. Walton’s little warehouses across the land clearly aim for a
consumer that is willing to buy more at a lower price per unit. Finally,
2nd degree price discrimination yields itself well to a process called
“product bundling”. Product bundling is more common in the personal
computer industry. System packages are bundled together with the
most popular software and hardware, and this reduces possible arguing
over certain items. No one can argue about the value of not including a
CD-ROM or video card. Third degree price discrimination deals with
separating customers into distinct groups based upon their difference
in elasticity of demand. Based upon this elasticity, you then charge a
higher price to the group whose demand is less elastic. Marginal
revenue is the change in the total revenue that is the result of a small
change in the sales of the good in question. Therefore, price must also
have to change slightly. Opportunity Cost Price discrimination is
based upon the most significant of all economic concepts: opportunity
cost. For example, American Airlines may offer college students a fare
from Saint Louis to Chicago for $149 round-trip, while “business class”
fares run significantly higher, say $279 for example. The business
traveler, is more willing to pay the higher fare because he or she is
going to be working for a client in Chicago and will be paid $100 per
hour while there. The college student does not have the luxury of
having any extra money, and therefore cannot see paying the higher
rate to travel to Chicago for his or her break. Opportunity cost is the
most essential measure of justification for any person’s given resources,
including (but not limited to) time, money, and talent. People often say
that they are “richer in time than in money”. The bottom line is always
that, no matter what you’re doing, you could be doing something else.
Opportunity cost should be a consideration every time someone chooses
to sleep in and miss class, or every time that someone takes off work for
a day. Vacation, after all, is the most common exercise of someone
making a judgment regarding opportunity cost. Price discrimination is
a significant and influential practice on the market in the modern
economic world. It aids in a firm’s profit maximization scheme, it
allows certain consumers with more scarce resources the opportunity to
purchase goods or services that would otherwise be usable, and it aids
firms in balancing what is and what is not sold. Price discrimination is
an effective means by which a firm can sell a higher quantity of goods,
make a higher profit margin on the goods it sells, and builds a broader
consumer base due to differing price elasticity of demand for given
goods and services. Price discrimination ultimately equalizes price and
value for both the consumer and the firm, creating a more ideal
situation for both entities in terms of preference and opportunity cost.