Price discrimination and pricing in practice

1. Meaning

Price discrimination is the practice of selling the same product, produced at the same cost, at different prices to different buyers or in different markets. Joan Robinson: “the act of selling the same article, produced under single control, at different prices to different buyers.” It is possible only where the seller has some monopoly power. A difference in price that reflects a difference in cost (for example, transport to a distant place) is not discrimination.

2. Types (by basis)

• Personal: different prices to different persons according to their income or need. A doctor or lawyer charges a rich client more than a poor one.
• Geographical (local): different prices in different places. When the domestic price is higher than the export price, it is called dumping.
• According to use (trade): electricity is sold cheaper for agriculture and industry than for households and commerce.
• Age and status: concessional fares for children and senior citizens, and student discounts.
• Time: lower telephone or cinema rates at off-peak hours; seasonal discounts.
• Quality and brand: the same product sold under a premium label at a higher price.

3. Degrees (Pigou)

A.C. Pigou, in The Economics of Welfare (1920), distinguished three degrees:

1. First degree (perfect discrimination): each buyer is charged the maximum he is willing to pay for each unit. The seller takes the whole of consumer’s surplus. Rare in practice; a doctor bargaining with each patient comes close.
2. Second degree: buyers are divided into groups by the quantity bought, and a different price is charged for each block (slab rates for electricity or water). Part of the consumer’s surplus is taken.
3. Third degree: the market is divided into sub-markets by some feature (place, age, use), and a different price is charged in each. This is the most common form.

4. Conditions for price discrimination

1. Monopoly power: under perfect competition, no seller can charge more than the market price.
2. Separation of markets: buyers in the cheap market must not be able to resell to buyers in the dear market. Markets may be separated by distance, tariffs, the nature of the good (services such as a doctor’s cannot be resold), legal sanction, or consumer ignorance and preference.
3. Different elasticities of demand in the markets. If elasticity were the same, discrimination would not raise profit.
4. The cost of keeping markets separate must be less than the extra revenue.

5. Equilibrium of the discriminating monopolist

The monopolist decides total output where combined MR equals MC, and then divides it between the markets so that MR is equal in each: MR_A = MR_B = MC. If MR were higher in A, shifting a unit from B to A would raise revenue. Since MR = P (1 − 1/e), equal MRs with different elasticities mean different prices: the higher price is charged in the market with less elastic demand.

Worked example. MC = Rs. 30. Elasticity of demand is 2 in market A and 4 in market B. At equilibrium MR = 30 in both.

The less elastic market A pays Rs. 60, the more elastic market B Rs. 40. In the diagram, draw the AR and MR curves of each market side by side and the aggregate MR curve with the MC curve in a third panel; a horizontal line from the point where aggregate MR = MC cuts each market’s MR curve and fixes its output, and the AR curve above gives its price.

6. Is price discrimination good or bad?

Against: it transfers consumer’s surplus to the seller, and some buyers pay more than cost; it can be used to drive out rivals (predatory pricing); dumping can damage the importing country’s industry.

For: it may make production possible where a single price would not cover cost (a railway line or a hospital in a poor area); lower prices for the poor (concessional fares, lower fees) serve a social purpose; dumping can help a firm use its full capacity and earn foreign exchange; and it may increase total output above simple monopoly.

The legal position in India. Section 4(2)(a) of the Competition Act, 2002 treats a dominant firm’s imposition of a discriminatory price (including a predatory price) as abuse of dominant position. Anti-dumping duties may be imposed under the Customs Tariff Act, 1975.

7. Pricing in practice

Joel Dean (“Pricing Policies for New Products”, 1950) set out the two classic strategies for a new product.

Skimming pricing. A high initial price is set to “skim the cream” of the market: buyers who are willing to pay much for a new product. The price is lowered later to reach wider groups. Suitable when demand is inelastic at first, the product is new and unique, patent protection limits rivals, and the firm wants to recover development costs quickly. New smartphones and medicines are examples. Risk: high prices invite rivals.

Penetration pricing. A low initial price is set to enter the market quickly and win a large share. Suitable when demand is elastic, economies of scale lower cost at large output, competition is strong or expected, and the firm wants to discourage entry. Examples: low-priced mobile data plans or small sachets of shampoo. Risk: low early profits, and buyers may resist later price rises.

Product life cycle pricing. Price is changed as a product passes through the stages of its life:

1. Introduction: skimming or penetration pricing, depending on the product and market.
2. Growth: sales rise and rivals enter; prices are reduced gradually and advertising stresses the brand.
3. Maturity: competition is keen; prices fall to the competitive level, discounts and offers are used, and the firm defends its share.
4. Saturation and decline: demand falls; prices are cut to clear stocks, or the product is withdrawn or modified.

How this is examined

“What is price discrimination? Explain its types” was a 10-mark essay in June 2025 (80-mark); “Price discrimination” was a short note in January 2026 (100-mark, Q.8) and “Types of price discrimination” in June 2025 (100-mark, Q.8). “Penetration pricing” was a 6-mark note in June 2025 (80-mark). For a short note on pricing, define the strategy, give the conditions and an example, and contrast it with the other.