pricing that are closely related to price discrimination (although not always
called by that name). For instance, resorts in Florida and the Caribbean set
much higher nightly rates during the high season (December to March) than
at off-peak times. The difference in rates is demand based. (The resorts’ oper-
ating costs differ little by season.) Vacationers are willing to pay a much higher
price for warm climes during the North American winter. Similarly, a conven-
ience store, open 24 hours a day and located along a high-traffic route or inter-
section, will set premium prices for its merchandise. (Again, the high markups
are predominantly demand based and only partly based on higher costs.) Like-
wise, golf courses charge much higher prices on weekends than on weekdays.
Each of these examples illustrates demand-based pricing.FORMS OF PRICE DISCRIMINATION It is useful to distinguish three forms of
price discrimination. The practice of charging different prices to different mar-
ket segments (for which the firm’s costs are identical) is often referred to as
third-degree price discrimination.Airline and movie ticket pricing are exam-
ples. Prices differ across market segments, but customers within a market seg-
ment pay the same price.
Now suppose the firm could distinguish among different consumers within
a market segment. What if the firm knew each customer’s demand curve? Then
it could practice perfect price discrimination. First-degree,or perfect, price
discriminationoccurs when a firm sets a different price for each customer and
by doing so extracts the maximum possible sales revenue. As an example, con-
sider an auto dealer who has a large stock of used cars for sale and expects 10
serious potential buyers to enter her showroom each week. She posts different
model prices, but she knows (and customers know) that the sticker price is a
starting point in subsequent negotiations. Each customer knows the maximum
price he or she is personally willing to pay for the car in question. If the dealer
is a shrewd judge of character, she can guess the range of each buyer’s maxi-
mum price and, via the negotiations, extract almost this full value. For instance,
if four buyers’ maximum prices are $6,100, $6,450, $5,950, and $6,200, the per-
fectly discriminating dealer will negotiate prices nearly equal to these values. In
this way, the dealer will sell the four cars for the maximum possible revenue. As
this example illustrates, perfect discrimination is fine in principle but much
more difficult in practice. Clearly, such discrimination requires that the seller
have an unrealistic amount of information. Thus, it serves mainly as a bench-
mark—a limiting case at best.
Finally, second-degree price discriminationoccurs when the firm offers dif-
ferent price schedules, and customers choose the terms that best fit their needs.
The most common example is the offer of quantity discounts: For large vol-
umes, the seller charges a lower price per unit, so the buyer purchases a larger
quantity. With a little thought, one readily recognizes this as a form of prof-
itable price discrimination. High-volume, price-sensitive buyers will choose to
purchase larger quantities at a lower unit price, whereas low-volume users will102 Chapter 3 Demand Analysis and Optimal Pricingc03DemandAnalysisAndOptimalPricing.qxd 8/18/11 6:48 PM Page 102