Question

Differential Rail Pricing Employed by a UK Rail Company: A Case Study in Price Discrimination

Introduction

The discussion is about Virgin Trains and its joint venture with the Stagecoach Group. The focus will be on the Virgin Trains East Coast line which operates between London and Edinburgh. East Coast has a market share of “just over 30 per cent” of the public transport market including airlines which are also in competition with the railways The discussion will focus on Virgin’s ability to vary its pricing between peak and off peak periods of the day. It also has the technological ability to charge different prices according to how far in advance the passenger is booking.

Discussion

Virgin has managed to successfully increase the number of passenger journeys by exploiting their dominant market power through price discrimination. Business travellers pay more for their rail tickets while leisure travellers tend to pay less because they can be more “flexible with their travel plans" The offer of cheap fares has been used to fill the trains during off peak periods.

Price discrimination has been used by Virgin to segment the travel market so that revenue can be maximised. There is a difference between the peak (commuting) period where the price elasticity of demand is inelastic and the off peak (leisure) period where price elasticity is price elastic .. Under price discrimination, the monopolist rail company assumes that some business travellers are willing to pay a price above a level where marginal cost equals marginal revenue. The monopolist rail company (Virgin-Stagecoach) seeks to “maximise revenue and generate excess profit” . It is for this reason that the monopolist does not want to charge a single price. Instead, they will segment the market and charge more to consumers who are willing to pay extra to travel at the peak period.

Virgin will want to maximise its load factor, which measures its ability to sell all of the available seats on the train . The train operation is a fixed cost and operates regardless of whether there are no passengers or whether the train is full. There will still be fuel and staffing costs which do not vary according to the number of passengers. It is necessary for Virgin to sell as many train tickets as possible to offset its costs. Demand theory suggests that additional demand can be generated from lower prices. If a passenger wants a train ticket 3 months in advance then they can purchase one for a low price. This is because there are many seats available and Virgin wants to make sure that they achieve a sufficient level of sales. Once a sufficient level of rail sales has been obtained then they can charge a higher price to later ticket bookers.

Answer the following Questions

Mention the first two degrees of price discrimination? What degrees of price discrimination are practiced by the UK Rail Company?

How is price discrimination beneficial to the monopolisr UK railt?

Is the concept of elasticity in any way related to price discrimination? Explain diagrammatically drawing references from the case?

Answer 1

1.

• With price discrimination, a seller charges customers a different fee for the same product or service.
• With first-degree discrimination, the company charges the maximum possible price for each unit consumed.
• Second-degree discrimination involves discounts for products or services bought in bulk, while third-degree discrimination reflects different prices for different consumer groups.

All the three degrees of price discrimination are practised by the UK rail company. It uses the second degree and third degree price discrimination more than the first degree price discrimination.

2. The monopolist rail company (Virgin-Stagecoach) seeks to “maximise revenue and generate excess profit” . It is for this reason that the monopolist does not want to charge a single price. Instead, they will segment the market and charge more to consumers who are willing to pay extra to travel at the peak period.

3.

In a competitive market, price discrimination occurs when identical goods and services are sold at different prices by the same provider. In pure price discrimination, the seller will charge the buyer the absolute maximum price that he is willing to pay. Companies use price discrimination in order to make the most revenue possible from every customer. This allows the producer to capture more of the total surplus by selling to consumers at prices closer to their maximum willingness to pay.

Price discrimination: A producer that can charge price Pa to its customers with inelastic demand and Pb to those with elastic demand can extract more total profit than if it had charged just one price. The purpose of price discrimination is to capture the market’s consumer surplus. Price discrimination allows the seller to generate the most revenue possible for a good or service.

Price is usually charged high for an inelastic market while price is charged less for an elastic market. Business travellers pay more for their rail tickets because they have inelastic demand while leisure travellers tend to pay less because they can be more “flexible with their travel plans" The offer of cheap fares has been used to fill the trains during off peak periods