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Price Discrimination Essay Research Paper Price DiscriminationPrices

Price Discrimination Essay, Research Paper


Price Discrimination


Prices are based upon the price elasticity of demand in each given


market. In other terms, this means that during ladies night at the local


bar, it costs more for men to have a beer than women simply because


these bars find it o.k. to charge females less, as a way to draw more


females to the business on a specific night. Price discrimination is part


of the commercial and business world. Movie theaters, magazines,


computer software companies, and thousands of other businesses have


discounted prices for students, children, or the elderly. One important


note though, is that price discrimination is only present when the exact


same product is sold to different people for different prices. First class


vs. coach in an airline (though sometimes just differing in how many


free drinks you can get) is not an example of price discrimination


because the two tickets, though comparable, are not identical. Price


discrimination is based upon the economic idea of marginal analysis.


This process deals specifically with the differences in revenue and costs


as choices and decisions are made. Profit maximization is achieved not


when the number of products sold is the highest, or when the price is


the highest. . Groups that are more sensitive to prices, (students and


senior citizens for example), have a lower price elasticity of demand and


are the ones that are often charged the lower prices for the identical


goods or services. The key to price discrimination and using it to fully


compliment other economic practices, ultimately achieving the total


profit maximization, is the ability to effectively and efficiently collect,


analyze, and act upon data gathered about the different groups. First


of all, the groups must be accurately identified and the differences


between groups must be thought of ahead of time. Children, genders,


and senior citizens are easily singled-out by appearance, while military


personnel, college students, and other groups must carry some sort of


identification. Firms typically will quote the highest prices in


advertisements, and then offer discounts to qualified groups. The three


basic conditions for price discrimination to be effective are: 1)


Consumers can be divided into and identified as groups with different


elasticities of demand. 2) The firm can easily and accurately identify


each customer. 3) There is not a significant resale market for the good


in question. The thought process behind the practice of first degree


price discrimination is that the firm has enough accurate information


about the consumer, and that products can be sold each time for the


maximum amount that the consumer is willing to pay. The two more


common examples of first-degree price discrimination is called “price


skimming” and “all-or-none offers”. Skimming refers to the demand


function, as firms take the top of the demand of a given good to


maximize profits on the sale. This, of course, requires that the firm


know the actual demand for the good that it produces. The firm must


divide its customers into distinct, independent groups based upon their


respective demands for the good. The firm wants to first sell to the


group who will pay the highest price for the new product. It then


reduces the cost slightly and sells to another group with only a slightly


less demand for the good. This process is copied on numerous occasions


until the marginal revenue drops to equal marginal cost. While this


example may seem similar to other examples of price discrimination,


you should remember that the most significant difference here is that


there are a virtually limitless number of possible prices that, if charges


correctly, will lead to profit maximization in the end. The firm must, of


course, be on the ball and must make constant changes of the demand,


and the price for the good, at any given time, after the initial price is


set, and a number of units are sold. Firms practicing price skimming


will generally start their pricing schedules where the demand schedule


has its vertical interception. From there, as the demand at any given


price shrinks, the firm readjusts the price of the good to get more sales.


As before, the firm maximizes profits where the marginal revenue is


equal to marginal cost. The firm will not continue to sell the good


below this point. The trick to price skimming is that the consumers do


not become accustomed to the process and therefore “wait” for the


prices to drop. Customers may be upset about paying a higher price


initially, and this may lead to the customer not becoming a return


customer next time, or simply t

hat the customer who bought at a high


price this time will hold off on a purchase next time, waiting for a price


reduction. Price skimming is no longer effective if the consumers have


been conditioned to the process. The other example of first-degree price


discrimination is the “all-or-none” model. This means that the firm will


set a price for a given good, and no matter what portion of the good


you desire, you pay the same price as if you were to purchase all of


them. The diamond industry is an example of this, often selling


less-than-perfect gems along with the perfect gems in order to get rid of


the less-desirable merchandise. By putting goods together in a “grab


bag”, firms can rid themselves of merchandise that would normally not


sell otherwise, or at least not for the same price. Likewise, firms can sell


larger than necessary volumes of certain items, even though no one in


his or her right mind would willingly purchase such large quantities of


certain goods. This format of moving merchandise is especially popular


at auctions. A branch of price discrimination, second degree is the


practice of selling incremental amounts of a good for incremental


prices. For example, the first 12 pairs of shoes are $80, the next 12 pair


are $72, and so on. The 2nd degree often allows the firm to sell more


quantity than they would ordinarily. Customers with higher demand


prices will tend to buy smaller quantities at higher average unit prices,


while those with lower demand prices will more often purchase the


larger quantities at a lower unit cost. Second degree price


discrimination generally leads to a situation where more quantity per


unit is sold. Sam’s Club is the 2nd degree price discrimination heaven.


Mr. Walton’s little warehouses across the land clearly aim for a


consumer that is willing to buy more at a lower price per unit. Finally,


2nd degree price discrimination yields itself well to a process called


“product bundling”. Product bundling is more common in the personal


computer industry. System packages are bundled together with the


most popular software and hardware, and this reduces possible arguing


over certain items. No one can argue about the value of not including a


CD-ROM or video card. Third degree price discrimination deals with


separating customers into distinct groups based upon their difference


in elasticity of demand. Based upon this elasticity, you then charge a


higher price to the group whose demand is less elastic. Marginal


revenue is the change in the total revenue that is the result of a small


change in the sales of the good in question. Therefore, price must also


have to change slightly. Opportunity Cost Price discrimination is


based upon the most significant of all economic concepts: opportunity


cost. For example, American Airlines may offer college students a fare


from Saint Louis to Chicago for $149 round-trip, while “business class”


fares run significantly higher, say $279 for example. The business


traveler, is more willing to pay the higher fare because he or she is


going to be working for a client in Chicago and will be paid $100 per


hour while there. The college student does not have the luxury of


having any extra money, and therefore cannot see paying the higher


rate to travel to Chicago for his or her break. Opportunity cost is the


most essential measure of justification for any person’s given resources,


including (but not limited to) time, money, and talent. People often say


that they are “richer in time than in money”. The bottom line is always


that, no matter what you’re doing, you could be doing something else.


Opportunity cost should be a consideration every time someone chooses


to sleep in and miss class, or every time that someone takes off work for


a day. Vacation, after all, is the most common exercise of someone


making a judgment regarding opportunity cost. Price discrimination is


a significant and influential practice on the market in the modern


economic world. It aids in a firm’s profit maximization scheme, it


allows certain consumers with more scarce resources the opportunity to


purchase goods or services that would otherwise be usable, and it aids


firms in balancing what is and what is not sold. Price discrimination is


an effective means by which a firm can sell a higher quantity of goods,


make a higher profit margin on the goods it sells, and builds a broader


consumer base due to differing price elasticity of demand for given


goods and services. Price discrimination ultimately equalizes price and


value for both the consumer and the firm, creating a more ideal


situation for both entities in terms of preference and opportunity cost.

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