hi everybody price discrimination occurs when a firm charges different prices to different consumers for an identical good or service with no differences in cost of production learn that definition in those four key ways and you'll get it right every time so there might be a person who's maybe charged £4 for a good or service but then there's somebody else for an identical good or service for no differences in cost of production is charged let's say £12 that sounds really dodgy right well how on Earth can a firm get away with doing something like like that well there are three conditions necessary for a firm to be able to price discriminate first of all they've got to have some kind of price making ability the ability to set prices and for that they need Monopoly power some kind of legal Monopoly power they need to have information to be able to separate the market into different Peds separate and identify different consumers via price elasticity of demand so for example they need to be able to identify groups of consumers with price in elastic demand so they can charge High prices but also identify consumers with price elastic demand where they can charge lower prices and thus are able to maximize their profits in the process but for that they need information and have you guys noticed that whenever we do our shopping online these firms want us to create accounts well why because then they can track what we do they can collect information and therefore segment us into different markets based on our ped but also firms have got to be able to prevent resale of a good they've got to stop somebody buying from where the price is lower and selling where the price is higher otherwise there's nothing good for the firm it's going to reduce profits for the firm so they got to be able to prevent resell like that we call that market C pitch so preventing that is also important there are three different degrees of price discrimination let's look at the first degree first deegree price discrimination is really dodgy it occurs when consumers are charged the exact price they're willing and able to pay for a good or service therefore eroding all consumer surplus in the market and turning it into Monopoly profit really really dodgy stuff here so if we take a normal market like this we've got a demand curve at a price of P1 consumer surplus would be this triangle here the area above the price line and beneath the demand curve that would be the consumer surplus but not if a firm is using first-degree price discrimination all of this consumer surplus would be turned into Monopoly profit and we can write that down here so consumer surplus consumer surplus is now turned into Monopoly profit as consumers are charged the exact price they're willing and able to pay for a good or service incredible to think this can happen but again if firms have got good information about us by all means they can do something like this now let's look at second deegree price discrimination there are many ways to look at second deegree price discrimination one way I'm going to look at it is with excess capacity pricing this is when you have a firm with fixed capacity so take a train company an airline company fixed number of seats you've got a cinema a theater Sports uh venue a hotel is a really good example with fixed number of rooms where it makes no sense to leave any of that capacity idle why because these companies have got fixed cost they need to pay so maybe what these guys do is last minute they lower their prices in order to fill that capacity and contribute towards their fixed cost you can consider this as last minute deals and we can illustrate that on a diagram uh let's take an example of a rail company or an airline company marginal cost Curve will look something like this so horizontal up to a point and that point is their capacity so let's call that qap it's logical to see that Beyond qap you can't produce anything more so the marginal cost curve the supply curve becomes vertical to represent that but beneath qap we have a horizontal marginal cost curve so if we take the example of a of an airline we can see that marginal cost is constant when it comes to filling one more seat on the plane the extra cost is simply maybe a meal you have to provide for that person the admin involved with sorting out the ticketing the check-in process the cost is always const constant the same argument applies whether it's a rail company whether it's a hotel we're assuming constant marginal cost here Revenue curves look just as normal so we have AR that looks like that we have Mr which is twice as steep so assuming this firm is a profit maximizer they're going to produce where MC equals Mr that gives us quantity q1 reading the price of the AR curve we get a price of P1 great and that will be maximizing profits for this firm but we can see that if they maximize profits like this there is going to be some excess capacity left the difference between qap and q1 and it makes no sense to leave that idle given the fixed cost that exists whether you're a hotel whether you're an airline whatever you've got fixed costs you need to pay here so what a firm might do is lower their prices to make sure that they can uh fill all of that capacity and th bring in Revenue to contribute towards that fixed cost and the logical place to go and price is here at Price P2 at Price P2 you can see that all the capacity is going to be filled and the revenue coming in can be used to contribute towards paying off fixed costs of the hotel of the airline company of the rail company whatever and you can see that by doing so the consumers that are able to buy last minute here at a lower price gain consumer surplus so consumers that pay the lower price for this excess capacity benefit from a gain of consumer surplus of this triangle here so that's the gain of consumer surplus so I'll say the gain of consumer surplus for those consumers who pay the lower price for that excess capacity that last minute deal and no doubt a lot of us have benefited from such last minute deals like this and it makes sense for the firm to do so so that's a nice diagram for you to use to show second degree price discrimination um not all bad news in this case some consumers benefit let's now move on and look at third degree price discrimination third degree price discrimination occurs when a firm is able to segment the market into different price elasticities of demand so there'll be one group of consumers with price inelastic demand one group of consumers with price elastic demand a firm will recognize that maybe based on time differences maybe based on age income or geography and therefore will charge different prices to those different groups so let's take an example of a rail company a rail company has identified different groups of consumers consumers with inelastic demand are those commuters who need to get to work and those with more price elastic demand Leisure Travelers the marginal cost curve for the rail company let's assume is constant just like we argued before so we'll say it's constant across both market segments here so we take that across and we'll just call that the marginal cost for the same reason we argue it as before and that is to fill one more seat on the train the cost is the same each time okay so constant marginal cost here right we need to draw our Revenue curves well our demand curve our AR curve if demand is priced in elastic is going to be quite steep whereas here it's going to be more shallow so let's make that clear let's say demand is going to look something like that so there's AR which is demand Mr is going to be twice as steep as that and over here much more shallow so let's say AR is equal to demand looks something like that and Mr twice as steep something like that so there's the different price elasticities of demand uh here the peak consumers and here the off peak consumers when it comes to using rail well what's a firm going to do they're going to profit maximize in each case charging and producing what MC equals Mr so let's take mcals Mr in both cases well that's here let's call that quantity q1 they're going to read the price of the AR curve that's going to take us to here let's call that price P1 let's do the same thing over here so mcals Mr is over there call that quantity Q2 the price read off the AR curve call it P2 and we can see very clearly the different prices being charged in the different markets depending on P s naturally where demand is more priced in elastic that Peak consumers prices are going to be much higher to exploit the fact that demand is pricing elastic whereas where demand is more pric elastic prices are lower and we can see that instead of just charging One Price overall in the market by charging two prices this firm is able to maximize their joint profits we can see that if they charge P1 across in this market there'll be no demand at all so by being able to charge different prices to different consumers because are differing Peds this firm is able to maximize that joint profits um so this is third degree price discrimination here segmenting the market based on different peed values let's wrap up now and look at the pros and cons of price discrimination it seems logical to start with the cons the biggest con by far is the allocative inefficiency of a price discriminating firm this is a real real problem charging prices Way Beyond marginal cost exploited consumers drastically look at first-degree price price discrimination look at the price in elastic Market segment of third degree price discrimination this is really horrible news for consumers being exploited with such high prices but also the inequalities that come again first-degree price discrimination the inelastic Market segment of third degree price discrimination who are those consumers if those consumers are those on Lower incomes it could really widen income inequality in society and also the anti-competitive nature of pricing this really comes down to third degree price discrimination and looking what's happening in the more price elastic Market segment here and saying well if prices are driven down there if those lower prices are driving out competitors then this firm is going to be left with pure Monopoly power we don't want that at all that could be very anti-competitive there are some pros with with price discrimination we could argue with greater profits made by The Firm there might be more reinvestment potential and greater Dynamic efficiency benefits we know about Dynamic efficiency while by now with greater quantity think about higher quantity in both second degree and third degree price discrimination there could be greater economies of scale benefits and maybe in the future lower prices to Consumers over time some consumers do benefit from price discrimination in second degree yes and in third degree think about those in the price elastic uh Market segment here some consumers do benefit but nowhere near as much benefit as consumers that lose as a result of price discrimination so don't be thinking this is a great thing consumers win or anything like that only some consumers might benefit and cross subsidization benefits so the higher profits that firms make might be used to cross- subsidize uh loss making goods or services elsewhere in the business allowing those to still function and be provided to Consumers but don't look at this guys and think oh more Pros than cons absolutely not just because there might be more Pros than cons here that con here outweighs any of the pros that you might think this is really bad for consumers as price discrimination so don't be thinking it's it's more good than bad this Con needs to be weighed up significantly and it's a real issue so that's it with price discrimination guys it's a really weighty topic area very very useful for you to know this information in an essay thanks for watching really hope you found that interesting I'll see you all in the next video