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.