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3. Under what circumstances might a profit maximising producer practice price discrimination?

 

Price discrimination is a pricing method that determines different prices to different clients. Every unit of product or service has its utility. When e.g. for 1 toothbrush per month 1 can be paid, then for 10th maybe only 10p maximum. The same thing applies to producers as well. In price of 10p maybe only 100 is produced whereas in the price of 1 maybe 1000 is produced. They are known as demand and supply. In normal markets only one price is determined where all goods are sold. Consumers enjoy profits because they can buy all at the same price (when price is 50p they buy 3 toothbrushes, they would have bought the first one with 1, but now they do not have to). Same thing applies to suppliers.

This is shown below:

The idea of price discrimination is to transfer the consumers profit to producers. This is done by charging different prices from different groups of people for reasons other than transport costs. For example telephone charges are higher in business hours because businessmen need to use the phone and do not care about the costs, they are cheaper in evening times to encourage ordinary people to make more calls.

Anyway to use price discrimination, several assumptions should be fulfilled. Firstly there should not be any close substitutes available, because then people might use them instead. So price discrimination can occur in monopoly.

Secondly the producer must keep the market separate, so that no resale of the product is possible. In example above obviously no resale was possible, there was a difference in the time at which the product (service) was sold. Anyway the separation of the markets can also occur if there is a geographical difference, a difference in the type of demand (e.g. personal services - hairdressers) or a difference in the knowledge of the consumer.


Thirdly two markets with different elasticities of demand. In the example above the market of business-clients was with inelastic demand (they used the service no matter what the price was) and the market of ordinary people was with elastic demand (they could reduce their demand if price rises and e.g. send a letter). All this is described in the graphs below:

So as seen the producer can use price discrimination when it is monopoly, has two (or more) markets with different elasticities of demand, which the producer can keep in separate. Price discrimination is successful when costs do not rise when selling on different markets. Price discrimination is used by monopolies like British Gas (cheaper price at night), BT and many others.

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