Demand Analysis and Optimal Pricing
Price Discrimination Price discrimination occurs when a firm sells the same good or service to different buyers at different prices.15 As the following examples suggest, price discrimination is a common business practice. • Airlines charge full fares to business travelers, while offering discount fares to vacationers. • Firms sell the same products under different brand names or labels at different prices. • Providers of professional services (doctors, consultants, lawyers, etc.) set different rates for different clients. • Manufacturers introduce products at high prices before gradually dropping price over time. • Publishers of academic journals charge much higher subscription rates to libraries and institutions than to individual subscribers. • Businesses offer student and senior citizen discounts for many goods and services. • Manufacturers sell the same products at higher prices in the retail market than in the wholesale market. • Movies play in “first-run” theaters at higher ticket prices before being released to suburban theaters at lower prices. When a firm practices price discrimination, it sets different prices for different market segments, even though its costs of serving each customer group are the same. Thus, price discrimination is purely demand based. Of course, firms may also charge different prices for the “same” good or service because of cost differences. (For instance, transportation cost may be one reason why the same make and model of automobile sells for significantly different prices on the West and East coasts.) But cost-based pricing does not fall under the heading of price discrimination. Price discrimination is a departure from the pricing model we have examined up to this point. Thus far, the firm has been presumed to set a single market-clearing price. Obviously, charging different prices to different market segments, as in the examples just listed, allows the firm considerably more pricing flexibility. More to the point, the firm can increase its profit with a policy of optimal price discrimination (when the opportunity exists). 15
Here, we are discussing legal methods of price discrimination; that is, we are using the term discrimination in its neutral sense. Obviously, the civil rights laws prohibit economic discrimination (including unfair pricing practices) based on gender, race, or national origin. The antitrust statutes also limit specific cases of price discrimination that can be shown to significantly reduce competition.
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