Need to learn about perfect price discrimination and how it is apply? Companies often experiment with different pricing policies to determine those optimal conditions which can generate maximum profit for the enterprise. Furthermore, testing with different systems also gives them an idea of the policy which can give them more control over product pricing and to get the most out of it. Some companies charge by the quality difference of the same product, while some charge different customers with different prices even for the same services and products.
Price discrimination, one of the most common pricing policies, is the practice of charging differently to different customers, i.e., either individually or grouped. Moreover, with its three degrees (first, second and third degrees respectively) in action. The companies move one hand further at taking some more bucks out of their customers’ pockets. So, what is perfect price discrimination?
Perfect price discrimination is, actually, the first degree of price discrimination policy often implied by monopolists, who have a market for their products or services. These discrimination levels work on the idea of segmenting the whole consumer base in the form of separate individuals. Also charging them with what they can bear; and what they are willing to pay.
As sellers or service providers charge whatever they want, therefore, they can extract maximum possible consumer surplus for themselves. And if segmentation proves successful, then average revenue is treated as marginal revenue. Now that’s where the marginal cost of production controls that extra income, which a monopolist gets from selling additional units. In simple words, sellers get that entire extra juicy surplus that’s why they also name it as “the ultimate form of discrimination”.
Conditions to Apply Perfect Price Discrimination
Application of perfect price discrimination is possible only under certain circumstances because beyond these conditions. Then there will be no reason for the discrimination to exist just like a GENIE of the lamp.
Distinction of price elasticity of demand
For discrimination to work, the firm must be able to divide the market into elastic and inelastic price demands. Inelastic demand comprises the group with, somewhat; strict charging policy. So where elastic demand being the group that gets charged less than the inelastic one. In this way, the firm can charge elastic demand to cover up the costs as well as some profit, if desired while inelastic demand feeds it with some extra juice. This can lead the firm to achieve a high level of surplus.
Keeping the Separation
For the long-term success of discrimination, the firm must seek ways to keep the two markets, i.e., elastic and inelastic demands, separated. For this purpose, you take advantage of either physical distance, nature of use or time differences like differences in electricity charges for different time periods. The cost per unit of electricity at peak time is kept high as compared to that of, off peak timings. Or if you ever been to a fair, you might have noticed that the entry of a child below a certain age limit is free. Moreover above that age the entry fee increases and for adults, it’s maximum. It works just like that.
Market of your Product
The market for the product! Yes, you read it right. Having your product in the market is not sufficient for discrimination to work; there must be some demand for your product. Let’s say, a service similar in quality is available in the market, and you put perfect price discrimination policy to your use. Do you think that customers will even look towards you except if your business is popular and has some authenticity in it? That’s why monopoly is the most satisfied condition for your price discrimination to be fruitful.
Putting a Barrier to Seepage
Consumer switching between two demands is what destroys the discrimination policy. Suppose, you are selling a product and by one way or another. I come to be a part of elastic price demand. And I buy your product at a lower price. Then, I go somewhere else to sell it to inelastic price demand for a higher price but lower than yours. It is evident that the requester will prefer to buy from me as compared to you. That’s how “consumer switching” named thing works.
Although the concept of user switching seems to be simple, the mind used behind executing it is sophisticated enough. In the case of services, that are provided to you on the behalf of your brand name, cannot be provided by anyone else. So, the concept of seepage between the demands ceases to exist. In the case of physical products, price discrimination is not easy to achieve.
However not impossible! You can put up some time limit on your products like a product that can only be used within a particular period of time e.g. Airlines sell their flight tickets which no one can either resell or reuse under any conditions. Or you can put up some identification systems like software companies that make use of educational email addresses to give huge discounts to students only. The case becomes stricter when it comes to being only one user per address. That’s how they protect their product by use of digital ways.
Downsides of Perfect Price Discrimination
Well! At first look, all the fuss about perfect price discrimination may portray it be very attractive, but that’s just the bright side of the fact. The main difficulty that keeps the investors away is that the companies will have to achieve complete information about personal preferences about every single consumer and their willingness to pay for the cause of business. That’s not an easy task! Moreover, the costs involved in using the appropriate means of determining those preferences appear to be a huge mountain like a barrier in front of the investor. Furthermore, most of the time suppliers consider negotiating a price with customers, a disturbing thing. That’s why they prefer to make use of menus and price lists which lead to direct sales and trades.
Hello everyone! This is Richard Daniels, a full-time passionate researcher & blogger. He holds a Ph.D. degree in Economics. He loves to write about economics, e-commerce, and business-related topics for students to assist them in their studies. That's the sole purpose of Business Study Notes.
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