Price Discrimination or Differentiation
Price discrimination is a mechanism for fixing different prices for similar goods and services by the same producer in a segmented market. Such price differentiation is only effective in markets where both the consumer and the producer or service provider have perfect knowledge about the market forces and conditions. This, therefore, means that it is not possible for any given producer to charge different prices for the same product unless he or she has sufficient information about the consumer such as age, consumer preferences, and product loyalty. It is a common practice for some consumers to show some differences in purchasing behavior. Many producers opt to charge different prices for the same goods and services in the market with a view to increasing their sales revenues by acquiring the extra consumer surplus.
There are essential terms and conditions which must be met for price discrimination to be effective. Firstly, the producer should be able to split the target market into several market segments with different proportionate changes in demand and price of goods. The consumer should be in a position to identify the different consumer behaviors in the market and then charge different prices for the same goods accordingly. The producer or the firm must be able to identify the group of consumers who have the highest price elasticity of demand and those who are price inelastic. Higher prices are therefore charged to consumers who have a high degree of price inelasticity since they are less likely to change their purchasing behavior in favor of the cheaper products.
Secondly, the producer should put in place control measures to prevent some consumers from reselling the goods and services to other consumers at discounted prices. It is evident that secondary exchange may occur in price differentiation since those groups of consumers that purchase the goods at a lower price may respond by selling their already bought products to those who buy at a higher price. This resale behavior leads to stiff competition with the producer in both the short-run and long-run periods. This requires the consumer to have significant power to influence and control the market.
Price differentiation is broadly grouped into three categories which are based on consumer behavior and other factors such as the geographical location of consumer groups, product loyalty and consumers’ relationship with the producer. In most cases, the producer has the ability to assess and know the highest possible prices which the consumer is willing and able to pay for a particular commodity or service. This means that the producer is able to fix different prices for the same goods and sell them to different consumers. The economic focus here is to obtain the maximum consumer surplus. This pricing mechanism of fixing the maximum possible prices to different customers is as the first-degree price differentiation.
Consumer preferences form another basis for charging different prices for the same good or service. The price of a good usually varies with changes in quality and quantity for a normal good. It is possible for consumers to form distinct purchasing behaviors as a result of product quality and preferences. This, therefore, forms the second-degree price discrimination which involves transacting different prices for the same good as a result of different consumer preferences. The other type of price differentiation namely the third degree applies to groups of consumers with diverse characteristics. The producer can set different prices to consumers from a given geographical region as well as those with different ages, for instance, goods in densely populated areas are more expensive than those in remote areas.
Monopolistic competition is a market competition characterized by several producers and consumers who transact heterogeneous products and services. The many producers and consumers in a monopolistic competitive market show great attributes to product specifications, quality and location. Even though the goods satisfy the same human needs and want, they have several differences which help to attract the consumer, for instance, the central role of all mobile phones is to convey relevant information from one person to another, but there different mobile specifications and models such as Nokia, Samsung, and Alcatel. The products are not close substitutes hence the consumers in this market cannot switch from one product to other substitutes in case of changes in price. There is no particular producer or firm in a monopolistic competitive market who has great influence or control of the whole market. To add on, the actions of the competitors are not the key focus for the producers since they have the freedom to leave the market in case of continued losses. New firms are also not restricted to enter the monopolistic competitive market since there are very few barriers such as fixed costs of operation. The economic conditions such as government incentives and tax systems help to motivate or discourage new operations from firms.
The prices are set by individual firms, producers or service providers but not the economic interactions of the forces of demand and supply in the market. The effects of competitors on the price of goods and services are assumed to be negligible since consumers are more interested in product quality and brand. The number of competitors is relatively low compared to other markets such as a perfectly competitive market. The firms in a monopolistic competition market are able to charge higher prices for goods and services while retaining their customers.
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The above economic frameworks are very relevant to consumer behavior as they are always faced with unlimited wants which compete for satisfaction. However, the economic resources to satisfy such wants are limited in supply; hence the need to make economic decisions on what to satisfy first. It is also evident that the consumer cannot spend what is not in possession. The purpose of any rational consumer is to maximize the utility amidst the budget constraint of the income. The customer faces a major economic problem of choosing which good to buy and which one to forgo. This, therefore, means that there is a need to incur the opportunity cost of one item as a result of choosing to buy the other. This decision, therefore, shows that the consumer has to bring a balance between the preferences and the total expenditures to incur.
The strategy of price discrimination points out some key tools of consumer behavior. The law of demand and supply shows that an increase in the unit price of a normal good leads to a proportionate decrease in the quantity demanded. If the goods become more expensive, the consumer will buy less and vice versa. This, therefore, follows that price discrimination can decrease the amount the rational consumer is willing and able to buy. On the other hand, savings and personal investments are also affected by changes in price. The total income of the consumer is theoretically used as savings and expenditures. For an individual to achieve equilibrium output, the total savings and expenditures should be equal. Any deviation such as changes in the price of goods and services, therefore, affects the amount of consumer’s savings and investments.
Customers portray substitution behavior when prices increase. With consumer income held constant, an increase price of commodities will force to buy other substitutes, for instance, if two drinks, drink A and drink B serve the same purpose, an increase in the price of drink A will mean that the consumer will opt for drink B. The level of consumption by the consumer falls as prices of goods and services increase. With the budget constraint of income, consumers will likely substitute expensive goods with cheaper ones. This consumer behavior will, in turn, decrease the sales revenue and the producer will eventually suffer loss. On the other hand, if the income of the consumer increases, the net effect is an increase in consumption of the more expensive goods and services.
In the economic problem of increase in discounted prices of the daily and weekly publications at the Student Union shops in the university, it is evident that the publishers were using price discrimination to maximize their sales revenue. In this perspective, however, the assumption is that there was only one publisher and all the articles were similar hence satisfying the same need in different groups of students. It is very clear that there was a lot of daily demand from the students. In the microeconomic view, when demand for any good or service increases, the price of the commodity has to increase. Price discrimination is shown in this economic problem in the following ways below.
Most institutions are characterized by young people who have the desire for new information, updates and the current state of affairs. Many of the academic works and routine activities in most universities are communicated through daily articles. It is also a requirement from some lectures to make daily follow-ups in the type of articles published. The publishers took this advantage of the dire need and demand for the articles and charged high prices as a way of maximizing their sales revenue. Students were therefore charged with high prices since they could not retaliate and scare away the competitors. This is an example of the third-degree price discrimination since the age of the students was the major basis for charging such high prices. The fact that the publishers are operating inside the institution may also lead to an increase in the prices of the articles. Universities are usually densely populated. Increase in population means an increase in the ready market and purchasing power. Price discrimination is easily enforceable such a densely populated location.
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Many students are largely characterized by product loyalty and preferences. On the other hand, producers take advantage of consumer preferences and loyalty to charge high prices for goods and services. In this case, the publishers had the choice of raising the normal prices for the articles since the students were already used to buying the articles. Similarly, the high prices of the articles in the university could be due to the monopoly power of the publishers. There may be restrictive measures from the publishers which may prevent the students from setting their own cheaper press where they can easily access their materials. Monopolies have the ability to manipulate and control all the pricing decisions in the market. These restrictions may hinder other new firms from entering the market. Students may be denied work permits and location facilities inside the institution.
A market without resellers is always characterized by very expensive goods and services. The producers in such markets do not fear the economic and social effects of the instant price increase. Our economic problem of the abnormal increase in the price of articles and publications in the university is a good illustration of this situation. In many of the cases, students’ activities revolve around academic works only with little or no attention being made in business activities. Most of them may never get access to cheaper articles which they may sell to others at some agreed discounts rates. Resellers act as intermediaries between the producer and other consumers. They emerge in areas where price discrimination is eminent. Their focus is usually on buying goods from the primary producer and then selling them to other consumers at a relatively higher price. It is possible that the students could not adopt some measures for buying and reselling the articles in a cheaper way.
The effects of monopolistic competition are also applicable to our economic problem in question. The university is composed of many students or consumers as well as publishers. The various news publications may be sold at very high prices because of the way they are differentiated with a view to meet the preferences, quality, and specifications of various groups of students. This means that the increases in the price of the articles could not be the major concern for the publishers but their major focus could be to maintain the quality of the daily articles. The students, on the other hand, could be interested in the nonprice aspects of the articles, hence making the publishers raise the prices.
In conclusion, similar products can be sold at different prices to different groups of consumers by one producer. Consumer behavior does not remain constant but it changes with a shift in the level of consumer income, geographical region, and age. The increase in the price of commodities does not necessarily affect the consumer negatively but it may be an indication of high product quality. However, high prices among goods and service providers may be an indicator of monopoly power, lack of resellers in the market and increased demand for the product.