4.3 Price Discrimination

What is price discrimination?

Price discrimination occurs when a firm charges different prices to different consumers for the same good, based on willingness to pay, not cost differences. It requires market power, the ability to segment markets/consumers, and the ability to prevent resale between groups. It's common with market power like monopolies or monopolistic competitors.

Why firms do it

By charging each group (or ideally each individual) a price closer to their maximum willingness to pay, firms capture more consumer surplus as producer surplus/profit. Examples: student/senior discounts, coupons, airline ticket pricing, and peak/off-peak pricing. Groups with more elastic demand get lower prices; less elastic (inelastic) demand groups pay higher prices.

Perfect price discrimination

In the extreme case of perfect (first-degree) price discrimination, a firm charges each individual customer exactly their willingness to pay. The firm's marginal revenue curve becomes the demand curve itself. This eliminates consumer surplus entirely — it all converts to producer surplus — but output expands to the competitive/allocatively efficient quantity where price equals marginal cost, eliminating deadweight loss.

Key terms

Price discrimination

Charging different prices to different consumers for the same good based on willingness to pay, not cost.

Requirements for price discrimination

Market power, ability to segment consumers, and ability to prevent resale.

Perfect (first-degree) price discrimination

Charging each individual consumer exactly their willingness to pay; MR curve = demand curve.

Effect of perfect price discrimination on surplus

Eliminates consumer surplus entirely, converting it all into producer surplus; eliminates deadweight loss.

Elastic vs. inelastic demand pricing

Firms charge lower prices to groups with more elastic demand and higher prices to groups with more inelastic demand.

Try an AP-style question

Price discrimination requires that the firm can…

1. sell identical prices
2. prevent resale between buyers
3. hide its costs
4. act as a price taker