Y2/IB 20) Price Discrimination – First, Second and Third Degree

okay one of my favorite topics in a to microeconomics is price discrimination which basically means that different consumers are being charged different prices you might have one consumer that's being challenged a high price but for the same product different consumer is being charged a lower price okay definite discrimination going on there how can that happen we see that all the time in the real world without going to understand why it happens and how it can happen then somehow we need to look at characteristics of firms so what needs to be existing for firms to get away with doing this first of all firms must have some degree of price making power they must be able to to some extent set different prices obviously further must also prevent what we call market seepage so if a consumer is paying a lower price can that firm stop the consumer selling that product himself to somebody else at a higher price okay especially that consumer is going to pay a higher price anyway they need to prevent that some especially across countries you see that a lot market seepage so let's say in the UK to buy a certain brand of cars in the UK costs actually quite a low amount the price is lower then let's hit in Europe well how do you prevent UK consumers buying cars and selling them at a higher price in Europe firms need to prevent that and that's what we call market seepage there must be also consumer groups that are out there who have very elasticity's of demand okay so you've got to have a group consumers that might you know have an inelastic demand you must have a different loop of consumers I don't want us internet which then lets you charge different prices to them okay so these are three conditions need to be are caring for price discrimination to work to set different prices different users right there are three different types of price discrimination three different degrees we're going to look at all three the first one is mainly theoretical case of first degree price discrimination occurs when every consumer is charged the price that they're willing to pay for a product so if we take a very basic market diagram right so let's go price and want media let's just have a demand curve like if the price was at price p1 we know that the level of consumer surplus is just the area above the prices below the demand curve right in first degree price discrimination though all of that consumer surface will be turned into monopoly profit I'll call it CS low consumer surplus okay turned into profit because now every consumer is charged the price that they are willing to pay so no consumer is benefiting from the price being lower than what they would have been ready to pay it's very very scary thought if that actually happened and one of my students told me actually Amazon how'd it go with this collecting loads and loads of data from how people shop on their website gathering all this information together and actually charging different prices the different consumers based on what they've done before it's a very very scary prospect so that no consumer has any surface every consumer is charged the price they're willing to pay a really scary thought obviously that's going to increase the profit for the firm massively doing so anyway that was found to be illegal but who knows I mean in the future with all the information that's out there the data that's been collected this actually might become a reality a very scary thought anyway that's first-degree this stayed still more theoretical than real we then also have second degree price discrimination which is also known as excess capacity pricing all right so basically this occurs when you have firms who might have excess capacity so let's look at theater companies as sports grounds airline companies rail companies these types of companies tend to have excess capacity right so an airline company might fill 75% of its plane well there's 25% of seats left there is excess capacity a sports ground might have sold 50% of their tickets well that means it's still hard to stand to be filled there's an excess capacity there's no point in leaving that capacity empty you may as well try and flog it off so you sell the excess capacity at a lower price this diagram is really funky but it makes the point very clear so price and costs quantity I'm going to start by drawing the marginal cost which takes this shape in second view of price discrimination let me explain so the initial path are the marginal cost curve is horizontal well if you think about let's take the enemy example again all right there are lots of fixed costs in maintaining an airline in operating an airline but actually the marginal costs are low and I've assumed to be zero in this case they fill an extra seat on a plane doesn't actually cause anything so that's why the marginal cost is zero to sell an extra ticket to fill out your seat in the stadium the marginal cost is is small or zero I see you need to pee in this case until you get to a state where you've filled all the seats in the plane you've filled all the seats in the stadium so full capacity you can't get any more quantity so the marginal cost speaker vertical you've hit your full capacity that's the shape of the marginal cost you have your normal demand curl-ups or demand which is your average revenue curve and your marginal revenue curve okay so the basic assumptions are still made all right you've got profit maximizing firms who produce what MC equals amount is down here that leads to quantity q1 and the price that you read out from the demand curve of p1 but the problem now is what a key one you still got excess capacity again you you've still got unknown 40 seats on the plane to be filled you still look in your theater and they're 20 seats that are left to be filled in the cinema you've got seats to be filled so you may as well find a way to sell it find a way to actually get people to occupy these seats if that means selling them at a price that do it there is we've still got fixed costs to pay there's no point in leaving the seats onion filled you may not try and fill them in and contribute towards your fixed costs so what is the logical place to do it well the logical place is here where the price is equal to the marginal costs are allocated the efficient level which then reduces your price there to p2 and under so now you're at full capacity okay so that's the logical place to do it because that is the full capacity and your price is still covering your marginal cost right so that's the place not if you tip today in doing so consumers that actually pay at the lower price p2 gained this area of consumer surplus okay by paying p2 instead of p1 they're gaining your consumers over this game but the firm is also gaining because they're actually still and making money here and they're using that money to contribute towards the fixed costs all right so it makes sense and that's why you might actually see if you go to let's take an example a theatre right you go to a theater let's say day before a show is taking place you might be able to get tickets the lower price for some airlines okay last-minute deals you might be able to get great last-minute deals because of the excess capacity hotels are a very good example what's the point of having empty rooms you may as well try to fill them up somewhere so that means reducing a price the day before will do it because you actually contribute towards your fixed cost so this is second degree price discrimination you got one set of consumers paying a higher price and once that occurs you take a lower price simply to flood off your excess capacity okay so that's that diagram there quite an interesting diagram I think and the last type of price discrimination is third degree price discrimination and this occurs when there are different Emacs kisses of demand for different types of consumers so the most obvious case I look at here is peak and off-peak travel okay so on the Left let's have peak on the right let's have off-peak okay so obviously consumers that are traveling let's in taking commuter trains they travel during peak hours so P cows are defined as you know morning hours between normally 7:00 and 9:00 o'clock I think P time off-peak time just basically anything that also peak times will be when you come back from where so the rush hour from 4 to 6 so in the peak times of travel consumers that take these trains look very inelastic tonight they need to get to work right so their demand that train travel is very interesting but at other times maybe leisure travel times demand is quite it again depends quite elastic there's no real need to travel if the price is so high so let's have a look and see what's going on here so we have got two diagrams ok I'm now going to draw my developers quiet and elastic here so if d is equal to AR and mrs is twice as steep wow that's a that's a pretty steep mr isn't it and here we've got more elastic demand curves okay and mr to be twice as steep right now I'm going to draw my marginal cost I'm going to assume again for the same reasons as before marginal cost is be horizontal okay marginal cost of your horizontal along there I'll label that I can label that marginal cost in red okay so again firms at profit maximizers so they're going to produce where MC is equal to M R alright so if a peak travel that occurs here and that leads to a price call that p1 and a quantity q1 in the off-peak travel market and sequels mi equals here and that leads to a price called p2 and the quantity Q – right okay that's the nitty-gritty other way basically in elastic elastic okay the key thing it note is this for travelers that travel during peak times look at the price that they pay they pay a much higher price then travelers and off-peak times who pay o mp2 very simply the elasticity of demand are being exploited the inelastic demand is being exploited here and as a result consumers have to pay a higher price and suffer where is it off control because demand is more elastic firms must know their prices if they try to keep the price the same at off-peak times there is no demand that exists at that price so there's no point charging it so if a third knows there is very very elasticity of demand that it should charge different prices in doing so it can maximize its profits in both markets segmentations so third degree price discrimination is also known as market segmentation okay where the market is divided up into different groups based on different missa T's and that can be done and they DS by age so maybe students have got a more classic demand where is a high income adults have got a more inelastic demand for something maybe it's by geography based on your location okay maybe again is based by income levels who knows what it might be but in some ways the mind is segmented and therefore consumers can be charged higher price or lower prices based on the fact that there are different universities okay so that's first degree second or third degree done if you had to evaluate this lets in an essay well the very simple way to start is that most cases consumer service suffers ok consumers are being charged high prices and you know some have been low charge lower prices as a whole consumer service fold as a third discriminating on price okay the only thing that doesn't quite happen is in second degree you could say we're actually some seats having sold the lower prices that for something to use benefit but on the whole consumer surface falls you can say well there is no negative efficiency here at all okay price on the whole is much much more than marginal cost levels so Alec efficiency is not being achieved here at all you could say well on the whole price discrimination is done for the benefit of firms isn't it really to increase their profits in its entirety not just in one type of market but among more different types of continues to exploit or to to discriminate to charge a a price as high as possible to make the highest level of profit as possible okay an argument for this where we could say if you've got two different markets you might say well if our firm is price discriminating in one market and making great profits than maybe they can cross subsidize a service as making a loss so maybe the profits being gained in one market through price discrimination should be a great benefit if it's used to cross subsidize or if it's used to innovate maybe so let's see that original but one of the most interesting topics of a tube you see this all the time in the world where different consumers have in charge different prices even though the product is exactly the same and costs are the same anyway that's all done see you next time

32 thoughts on “Y2/IB 20) Price Discrimination – First, Second and Third Degree

  1. If you're smart about it, price discrimination actually works in your favor as the consumer because they company massively discounts it for you to a point where it doesn't make sense not getting it as the alternative is more expensive. And as a consumer I like that. Because uber does price discrimination, a lot of the time I take Uber over the bus because uber is cheaper than the public bus! You would think no way, but way! It's a far better service for a cheaper price!

  2. For first degree price discrimination………… what if it's a cheap consumer and they say some ridiculously low price, wouldn't the producer lose?

  3. muchas gracias bro really i have exam tomorrow it really helps me me for that you are really great
    thanks man👌👌

  4. You prophesied! Net Neutrality FIRST Degree: Perfect price discrimination by the individual consumer. Each consumer pays exactly what he or she is willing to pay. Frightening!

  5. you're that kinda teacher who can make me study whole day. Tysm for your videos they really help me a lot . 🙏🙏

  6. Hello, can the tickets to a cinema or a zoo be considered as a prise discrimination, if for example Adult is paying £10, Student £7 and old people £5… Surely this is charging different prices for the same good/service.

  7. do we still need to learn about first and second degree price discrimination? i only saw third degree in the new spec for edexcel

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