Price Discrimination

Third-Degree Price Discrimination

In most cases, economists believe that price discrimination, while it increases firm profits at the expense of some consumers, actually increases societal welfare by allowing the firm to maximize profits while serving a variety of customers. The sale of AIDS drugs in the United States and Africa is an excellent case in point. If forced to sell AIDS drugs to all consumers in the world at the same price, drug manufacturers would likely choose a price that exceeded that which a typical African consumer could afford. By engaging in third-degree price discrimination, a pharmaceutical firm will charge high prices in rich countries but then lower the price to victims in poorer countries expanding the number of patients able to afford treatment. Similarly, book publishers immediately provide access to an author's latest work for those willing to pay the premium for a hardcover edition while later expanding the market to additional readers with the subsequent publication of a paperback.

Economists note that successful price discrimination requires several conditions to be in place. First, the firm or provider must have some degree of market power in order to be able to set prices above the equilibrium price determined in the marketplace. Next, the firm must have the ability to identify those willing to pay a high price for the good from those not willing to pay a premium. This can be accomplished in many ways from geographical pricing (as in the AIDS drug example) or age related pricing (student or senior discounts) to directly collecting information on buyers (direct disclosure of economic information on college financial aid applications.) Finally, the seller must have way to prevent those who purchase the good at a low price from reselling the good to others with a higher willingness to pay. This can be done through contractual prohibitions or the voiding of warrantees following resale. Services tend to be difficult to resell, and high transaction or transportation costs may also reduce resale. While generally legal, price discrimination is prohibited under the Robinson-Patman Act (1936) in cases where there is a substantial likelihood of a significant reduction of competition. This reduction of competition can take two forms. Primary line discrimination occurs when the price discrimination reduces competition in the market of the good itself.

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