Exercise 13.1 
Price Discrimination in Practice

     Everyday we encounter numerous examples of price discrimination. It occurs whenever a seller charges two separate customers a different price for the same goods or service that cost the seller an identical amount to produce. The Robinson-Patman Act of 1936 prohibits price discrimination under some very special circumstances. (The price discrimination must result in a substantial lessening of competition and is not due to pro-competitive market pricing.) Typically, price discrimination is perfectly legal and is employed by firms as a profit maximizing pricing strategy.

    The most common type of price discrimination is based upon market segmentation. The producer can take advantage of either a natural division of markets or can through the employment of various techniques divide consumers into separate markets with distinct demands for the product. In order for price discrimination to be profitable it is essential that:

  1. There are different price elasticities of demand for each group of consumers.
  2. Recontracting between groups of consumers is not possible. Basically, there is no secondary market in the product.
  3. The cost of creating distinct groups of consumers does not outweigh the benefits from price discrimination.

     To maximize profits the firm should charge a higher price to those who have a less elastic demand for the product and charge a lower price for those who have a more elastic demand for the product. In everyday language, the firm charges a higher price to those who are less willing to do without the good or service.  As a result, the firm will earn greater profits than an identical firm that charges the same price to all consumers on all units of the product.  Thus, under price discrimination there is a greater transfer of revenues away from consumers and toward the monopolist. On the other hand, the price discriminator produces more total output than a single-pricing monopolist. Thus, from the perspective of allocative efficiency, the price discriminator may be preferred.

     One word of caution, what sometimes may appear to be price discrimination may actually be differential prices based upon a cost justification. The basic price discrimination model assumes that the marginal cost of serving the segmented markets is identical. It is possible that some price differentials that we observe in the market may be entirely cost justified. These may be separate competitive markets with different cost structures.

Assignments:

1.

Find a real world example of price discrimination that was not discussed in class.
  1. Which market segment has a less elastic demand for the product? Why do you think the elasticity is greater in one of these markets?
  2. Does the pricing strategy appear to follow that suggested by economic theory? Why?
  3. Are there secondary markets in the good? If not, has the firm done anything to prohibit secondary markets?
  4. Could part of the price differential be explained by cost considerations?

2.

   A  New York City Council study shows that women pay more for haircuts, dry cleaning and clothing alterations. Is this a classic case of economic price discrimination? Does it fit the economic model discussed in this chapter? Should gender pricing be illegal? If it were illegal, what impact would it have on these types of goods?

See: LADIES GET TAKEN TO CLEANERS, STUDY SEZ, By DAVID L. LEWIS, Daily News (New York), September 28, 1996, Saturday, News; Pg. 7

3.

   Given an example of a price differential on the same physical product that is probably cost justified and not a result of price discrimination.

Related Links

bulletCollege bookstores generally get a smaller discount from publishers than other types of bookstores.Source: A textbook case of bias in pricing, Steven P.Garmisa, Chicago Sun-Times, December 3, 1997, WEDNESDAY, Late Sports Final Edition;YOU AND THE LAW; Pg. 72

07/27/05


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Ralph R. Frasca, Ph.D. 2007