Demand Analysis and Optimal Pricing 99Price Discrimination
Price discrimination occurs when a firm sells the same good or service to dif-
ferent 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 dif-
ferent 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 exam-
ined 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 pric-
ing 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
discriminationin its neutral sense. Obviously, the civil rights laws prohibit economic discrimina-
tion (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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