Question

Describe the differences between price non-discrimination and (i) first degree price discrimination, (ii) second degree price discrimination, (iii) third degree price discrimination, and (iv) peak load pricing. Provide a supporting example in each of these four cases. Note the market structure conditions in which each can apply, and explain the expected welfare outcomes in each case.

Answer 1

The ultimate aim of any company is to earn reasonable profits for itself in order to keep its company growing and to accumulate capital over a period of time.

For attaining profits, having a good pricing strategy which is based on the forces of demand and supply in an economy are very essential. It ensures that there is consistency in demand and expenses can be met while at the same time the company can provide sufficient returns to its shareholders.

In view of the case study, the details of the various forms of price discrimination is as described: -

1) First Degree Price Discrimination: -

When a firm charges the highest possible price per unit consumption for a product or a service, it is known as first degree price discrimination. Even though, there could be differences among the products being sold and their relative prices may be different, there is consistency in one product offering.

It is important that the company is aware of the maximum price which the customer is willing and able of paying. For example, in many Information and Technology companies in Asia, first degree price discrimination is used, wherein the prices are kept at a maximum level as the companies are aware that the product or service offering is still at a cheaper rate than foreign competitors. The expected gains are such, that the company is aware that its pricing is suitably accepted by the consumer and this can help in bringing profits for a firm respectively. This happens more in market types, wherein the competition is relatively negligible which gives the consumers with no alternative but to go for purchasing from the company respectively.

2) Second Degree Price Discrimination: -

Second degree price discrimination is done to encourage buyers to buy goods and services at a higher quantity. This involves charging the customer different per unit prices so that those that purchase in higher volumes can receive the product at a relatively cheaper per unit cost. For example, various super markets offer deals to its customers to enable higher volume sales to take place and is the characteristic of a market type with increased price competition.

3) Third Degree Price Discrimination: -

Third degree price discrimination takes place, when a firm tries and captures all types of customer segments in an existing market type by offering them different services on different prices so as to be able to capture people of all budgets and give them different segmented services. This type of structure is followed by a market with monopolistic competition wherein to undercut competition the services offered are different for each customer type.

A classic example of this is the airlines industry, wherein for different classes of people, the prices charged are different. Economy seats are priced cheaply than business classes and the services provided in each discriminated price therefore is different.

4) Peak Load Pricing; -

In peak load pricing, the maximum prices are charged during the season wherein the demand for such good types is high whereas lower prices and discounts are given during low demand cycle. These products are usually cyclical in nature.

For example, consider the market for Air conditioners. The highest price is charged during summers whereas during winters the prices charged are relatively lower so if you purchase one during the winter season, you would pay relatively lesser prices.

Please feel free to ask your doubts in the comments section.