What Is Price Discrimination? The Three Degrees

Price discrimination means charging different prices to different customers for the same good or service when the price difference is not explained by a difference in the cost of supplying it. The three degrees describe how the seller separates customers or purchases.

The three degrees

• First-degree: The seller charges each customer the maximum they are willing to pay for each unit. In theory, this transfers nearly all consumer surplus to the seller. Consumer surplus is the difference between what someone is willing to pay and what they actually pay.
• Second-degree: The price per unit varies with the amount bought or the version chosen. For example, a larger data package may have a lower price per gigabyte. Customers select from the options offered.
• Third-degree: The seller charges different identifiable groups different prices for the same product. A lower student ticket price than an adult ticket price is an example, provided the difference is not simply due to different supply costs.

When can it work?

A firm needs some market power, meaning it can influence the price it charges. It must also be able to distinguish purchases or customer groups and prevent customers who pay less from reselling to those charged more. For third-degree discrimination, groups usually differ in their responsiveness to price, known as price elasticity of demand.

Price discrimination can increase a firm’s revenue or profit and may allow some customers to buy who otherwise could not. But others may pay more, so its effects on consumers depend on the prices and quantities involved.

Exam mistake: Do not call every price difference price discrimination. First check whether different costs of supply explain it. In Cambridge International A Level Economics, this sits within Differing objectives and policies of firms and includes the conditions and consequences of price discrimination.