Competition and Markets
Price discrimination occurs when a company places dissimilar prices on goods that are the same, despite a cost sale that is the same to all the clients. In many cases, it involves charging a customer the highest price that they feel they can afford. In a much more precise way, it can be said to be the state when the selling price ratio to marginal cost ratio is different in sales that are made to another customer (O’Sullivan & Sheffrin, 2002). This goes to explain that even though different prices may be placed for the same product, it does not mean that price discrimination has occurred. This could be due to variations in cost. Price discrimination is a pricing strategy that usually occurs in different areas of the economy, which in turn affect the economy in ways that are diversified. Price discrimination can be either an advantage or a disadvantage to the economy. This paper is aimed at shedding some light on price discrimination within the economy, its types and advantages while giving reference to a case study.
In order for price discrimination to take place, it must meet some conditions. These conditions are: The Company should be able to have supra-competitive prices to give leeway for the discrimination to take place. If this is not the case, then it will be unsuccessful. This is mostly found in markets of high competition. The company should be in a position that they can charge customers the prices that they are willing and able to pay for. It is therefore necessary that the company learn about their customers in detail. The firm should also be capable enough to limit goods resale by customers that are buying the goods at low prices to other customers for a profit. If anyone or all of these conditions are deficient, then price discrimination is not going to successful take place (O’Sullivan & Sheffrin, 2002).
There are different categories of price discrimination. These categories are fashioned depending on the different effects that it has on the economy. First-degree discrimination of price takes place when a company succeeds to discriminate perfectly against its customers. This means that the firm charges each customer the maximum price that they are willing to pay for their good or services. It is however assumed that this is quite a difficult undertaking for it to be successful. The firm has to know perfectly about its customers, which in the real sense is impossible.
The second-degree discrimination of price, takes place when a company chooses to set a unit price for a product, which varies, depending on the quantity that the customer chooses to buy. This is done through the adoption of a tariff that allows the customer to pay a flat rate fee that does not take into account the quantity of their purchase. It can also be done by giving volume discounts. The third-degree discrimination of price takes place when a company groups its customers and charges them depending on demand elasticity. When the customers are of high demand elasticity, then the price charges are directly related. This means that they will be highly charged. Conversely, low demand elastic customers will be charged low prices as their relationship with price is inversely related. This is what is referred to as Ramsey pricing.
Several advantages accompany price discrimination. Firm’s revenue increases. This keeps them in as the loss margin is reduced. This is because it is possible in some businesses to find that no price would ensure the firm is able to make normal profits. So discrimination aids in filling that gap between profits and losses. Another advantage is that the increase in the revenue would be of much benefit to the customers, as the money would be used to carry out research and developments that they can use. Price discrimination gets rid of congestion. This is because demand is reduced. An example is given of a train company. During peak hours, fare prices are usually hiked while during off-peak hours, the opposite is true. This encourages people to travel within the cheaper times and therefore congestion is greatly reduced.
A company has to create pricing strategies that they can use to determine what prices to set for their customers. Several pricing strategies can be used. One of the strategies is competitive pricing, which is setting prices that are similar to those of your competitors. There is also cost-plus pricing and limit pricing. The former, involves the calculation of production cost and adding a percentage to get the selling price (Economics Help Shop, 2010). The latter is when a price limit is set for the goods or services that are provided. This is usually placed at a price that is much lower that the cost of production. It is done by monopolists to discourage new entrants into the market. There is also creaming or skimming. This is where the product is sold at a high price so that a high profit rate can be incurred. Other strategies are market-oriented pricing, penetration, premium, predatory, psychological, dynamic, target, absorption, high-low, marginal cost pricing or price leadership.
In the case study, titled ‘Taken to the Cleaners?’ the type of discrimination that is portrayed is third-degree discrimination of price. This is because the drycleaner has grouped his customers into men and women and charges different prices for each group. The men only get to pay $1.65 while women pay $5.25 for the same service. In many cases, this happens because the supplier of the service views the customers from the point of demand elasticity (Landsburg, 2010).
Although price discrimination does have its advantages, that is not always the case. This is especially when the degree of discrimination is that of the second or of the third. In some cases, it may be wise to keep focus on those clients that can afford to buy the products at the set price and ignoring those that cannot (Economics Help Shop, 2010). However, discrimination largely depends of the market that the firm is in.
O’Sullivan, A., & Sheffrin, S. M. (2002). Microeconomics: Principles and tools. Prentice-Hall series in economics. Princeton, N.J: Recording for the Blind & Dyslexic.
Economics Help Shop. (2010). Different types of Price Discrimination. Retrieved May 17, 2010 from http://www.economicshelp.org/microessays/pd/price-discrimination.html
Landsburg, S. (1998). Taken to the Cleaners? Retrieved May 17, 2010 from http://www.slate.com/id/2050/