Requirements for Profitable Price Discrimination

Price discrimination occurs whenever different classes of customers are charged different markups for the same product. Price discrimination occurs when different customers are charged the same price despite underlying cost differences, and when price differentials fail to reflect cost discrepancies.

For price discrimination to be profitable, different price elasticities of demand must exist in the various submarkets. Unless price elasticities differ among submarkets, there is no point in segmenting the market. With identical price elasticities and identical marginal costs, profit-maximizing pricing policy calls for the same price and markup to be charged in all market segments. A market segment is a division or fragment of the overall market with unique demand or cost characteristics. For example, wholesale customers tend to buy in large quantities, are familiar with product costs and characteristics, and are well-informed about available alternatives. Wholesale buyers are highly price sensitive. Conversely, retail customers tend to buy in small quantities, are sometimes poorly informed about product costs and characteristics, and are often ignorant about available alternatives. As a group, retail customers are often less price sensitive than wholesale buyers. Markups charged to retail customers usually exceed those charged to wholesale buyers.

For price discrimination to be profitable, the firm must also be able to efficiently identify relevant submarkets and prevent transfers among affected customers. Detailed information must be obtained and monitored concerning customer buying habits, product preferences, and price sensitivity. Just as important, the price-discriminating firm must be able to monitor customer buying patterns to prevent reselling among customer subgroups. A highly profitable market segmentation between wholesale and retail customers can be effectively undermined if retail buyers are able to obtain discounts through willing wholesalers. Similarly, price discrimination among buyers in different parts of the country can be undermined if customers are able to resell in high-margin territories those products obtained in bargain locales.

consumers' surplus

The value to customers of goods and services above and beyond the amount they pay sellers

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