Price Discrimination

Price discrimination occurs when a seller charges two or more prices for the same good or service.

Examples:

1. Doctors often charge rich patients 10 times as much for the same service as poor patients.

2. Airlines sometimes allow riders under 16 years of age to fly at half-fare ("youthfare").

3. The most notorious example of price discrimination was probably that of A&P during the 1940s. A&P had three grades of canned goods: A, B, and C. Grade A was presumably of the highest quality, B was fairly good, and C was— well, C was edible. My mother told me that she always bought grade A, even though it was the most expensive. Nothing but the best for our family. Our family was friendly with another family in the neighborhood. The husband, a man in his early 50s, found out he had stomach cancer. "Aha!" exclaimed my mother, "Mrs. S. always bought grade C!"

A few years later the Federal Trade Commission (FTC) prohibited A&P from selling grades A, B, and C. The FTC didn't do that because of Mr. S.'s stomach cancer, but because there was absolutely no difference among the grades.

Why had A&P concocted this elaborate subterfuge? Because it was worth tens of millions of dollars in profits! Take a can of green peas that had a demand schedule like the one in Table 1.

To keep things simple, suppose A&P had a constant ATC of 20 cents a can. How much should it charge? To figure this out, add a total cost column to Table 1 and then a total profits column. Now figure out the total profits at prices of 50 cents, 40 cents, and 30 cents, respectively.

In Table 2, these calculations are all worked out. If A&P could charge only one price, it would be 50 cents; total profit would be $30. Now let's see how much profit would be if A&P were able to charge three different prices.

Table 1

Hypothetical Demand Schedule for Canned Peas

Price	Quantity Demanded	Total Revenue
$ 0.50	100	$50
0.40	140	56
0.30	170	51

At 50 cents, A&P would be able to sell 100 cans. These are sold to the people who won't buy anything if it isn't grade A. Then there are those who would like to buy grade A but just can't afford it. These people buy 40 cans of grade B. Finally, we have the poor, who can afford only grade C; they buy 30 cans.

Table 2

Hypothetical Demand Schedule for Canned Peas

Price	Total Revenue	Total Cost	Total Profit
$ 0.50	$50	$20	$30
0.40	56	28	28
0.30	51	34	17

All this is worked out in Table 3. Total revenue now is $75 for the 170 cans sold, and total cost of 170 cans remains $34. This gives A&P a total profit of $41.

Table 3

Hypothetical Demand Schedule for Canned Peas, by Grades

Grade	Price	Quantity Demanded	Total Revenue	Total Costs	Total Profit
A	$ 0.50	100	$50	$20	$30
B	0.40	40	16	8	28
C	0.30	30	9	6	17
Sum			$75	$34	$41

Why is total profit so much greater under price discrimination ($41) than it is under a single price ($30)? Total profit would be $30 at 50 cents; it would be $28 at 40 cents; it would be $17 at 30cents. People are willing to buy only 100 cans at 50 cents, 40 more at 40 cents, and another 30 at 30 cents. But the people who buy only grade A will buy all their cans of green peas at that price, while those buying grade B will buy all their peas at 40 cents and grade C buyers will buy all their peas at 30 cents. By keeping its markets separate rather than charging a single price, A&P had been able to make much larger profits.

The firm that practices price discrimination needs to be able to distinguish between two or more separate groups of buyers.

In addition to distinguishing among separate groups of buyers, the price discriminator must be able to prevent buyers from reselling the product (i.e., stop those who buy at a low price from selling to those who would otherwise buy at a higher price).

If the 15-and-a-half-year-old buys an airline ticket at half-fare and resells it to someone 35 years old, the airline loses money. Most 15-and-a-half-year-olds don't have too much money, so that's a way of filling an otherwise empty seat; but when the 35-year-old flies half-fare and would have been willing to pay full fare, the airline loses money. In the case of A&P. there was no problem preventing the grade C customers from reselling their food to the grade A customers because these people voluntarily separated themselves into these markets.

Price discrimination is woven into our economic fabric, and in most cases it is basically a mechanism for rationing scarce goods and services. For example, since nearly everyone seems to want to go to the movies at 8:00 on Saturday night, the theaters encourage moviegoers to see films at other times by charging considerably less. But the main motivation for price discrimination is, of course, to raise profits. If price discrimination were carried to its logical conclusion, we would have perfect price discrimination.

To practice price discrimination you need to be able to (1) distinguish between at least two sets of buyers and (2) prevent one set of buyers from reselling the product to another set.