In economic theory, perfect competition desribes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets. Still, buyers and sellers in some auction-type markets, say for commodities or some financial assets, may approximate the concept. Perfect competition serves as a benchmark against which to measure real-life and imperfectly competitive markets.
Most businesses charge different prices to different groups of consumers for what is more or less the same good or service! This is price discrimination and it has become widespread in nearly every market. This note looks at variations of price discrimination and evaluates who gains and who loses?What is price discrimination?Price discrimination or yield management occurs when a firm charges a different price to different groups of consumers for an identical good or service, for reasons not associated with costs.It is important to stress that charging different prices for similar goods is not pure price discrimination.We must be careful to distinguish between price discrimination and product differentiation – differentiation of the product gives the supplier greater control over price and the potential to charge consumers a premium price because of actual or perceived differences in the quality / performance of a good or service.Conditions necessary for price discrimination to workEssentially there are two main conditions required for discriminatory pricing * Differences in price elasticity of demand between markets: There must be a different price elasticity of demand from each group of consumers. The firm is then able to charge a higher price to the group with a more price inelastic demand and a relatively lower price to the group with a more elastic demand. By adopting such a strategy, the firm can increase its total revenue and profits (i.e. achieve a higher level of producer surplus). To profit maximise, the firm will seek to set marginal revenue = to marginal cost in each separate (segmented) market. * Barriers to prevent consumers switching from one supplier to another: The firm must be able toprevent “market seepage” or “consumer switching” – defined as a process whereby consumers who have purchased a good or service at a lower price are able to re-sell it to those consumers who would have normally paid the expensive price. This can be done in a number of ways, – and is probably easier to achieve with the provision of a unique service such as a haircut rather than with the exchange of tangible goods. Seepage might be prevented by selling a product to consumers at unique and different points in time – for example with the use of time specific airline tickets that cannot be resold under any circumstances.Examples of price discriminationPrice discrimination is an extremely common type of pricing strategy operated by virtually every business with some discretionary pricing power. It is a classic part of price competition between firms seeking a market advantage or to protect an established market position.(a) Perfect Price Discrimination – charging whatever the market will bear Sometimes known as optimal pricing, with perfect price discrimination, the firm separates the whole market into each individual consumer and charges them the price they are willing and able to pay. If successful, the firm can extract all consumer surplus that lies beneath the demand curve and turn it into extra producer revenue (or producer surplus). This is impossible to achieve unless the firm knows everyconsumer’s preferences and, as a result, is unlikely to occur in the real world. The transactions costsinvolved in finding out through market research what each buyer is prepared to pay is the main block or barrier to a businesses engaging in this form of price discrimination.If the...