Price discrimination

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This article describes a pricing strategy used by sellers, typically in markets that suffer from imperfect competition, significant transaction costs or imperfect information.
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Price discrimination is the practice of a single seller selling identical goods (identical in terms of production costs) at different prices to different buyers.

Price discrimination is counter to the law of one price.

Conditions for price discrimination

The main problem with price discrimination strategies is the leakage of the low-price product to customers who might have been willing to pay the higher price.

Market power

Further information: Price discrimination requires market power

For a seller to practice price discrimination, i.e., to price the same good differently to different buyers, the seller must have at least some market power. For instance, if a seller has both a low price for some buyers and a high price for other buyers, another seller can come along and offer the same good at a medium price for all buyers. The other seller is thus able to steal the most profitable customers from the original seller, forcing the original seller to lower prices. In this manner, a competitive market erodes price discrimination.

Preventing high-price buyers from choosing low-price alternatives

Price discrimination requires strategies to prevent customers in the high-price segment form choosing the low-price version. The strategies are of two kinds:

  • Requiring certain eligibility conditions to qualify for the low-price product. The eligibility criteria may include geographic location (lower prices in developing and backward areas), time, or demographic characteristics of the buyer (for instance, student discount cards, senior citizen discount cards, clipper coupons).
  • Requiring customers to put in extra work to obtain the low-price product: This includes methods for arranging items in supermarkets so that price-insensitive customers are likely to pick the high-price versions while bargain shoppers are likely to pick the low-price versions.
  • Deliberately sabotaging low-price products at added cost to prevent people willing to pay a higher price from switching to the lower price: This is observed in knowledge goods. Further information: Price discrimination for knowledge goods
  • Using marketing techniques to make high price payers believe that the high-price product is different or superior.

Difficult to resell

If it is easy for people to resell goods obtained at the low price to buyers willing to pay the higher price, price discrimination is difficult to maintain.

Alternative explanations for apparent price discrimination

If price discrimination seems to be occurring, but the conditions necessary for successful price discrimination are not satisfied, there are likely to be alternative explanations. Alternative explanations to price discrimination usually hinge on hidden costs, such as opportunity costs, greater expectations of customers paying higher prices, and non-obvious differences in quality. Here are some examples:

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