Price discrimination is present in some form is present in most industries. Many consumers may find the idea of being charged a different price than another consumer, unsettling, however such discriminations may benefit both the consumer and producer of a good or service. When studying economic situations, models are used which make basic assumptions such as perfect competition (price-taking firms), transitivity of goods, and full employment, however real markets are much more complex and consumer surplus is a nemesis for firms that wish to maximize profits. Such market imperfections account for significant reasons for a firm to use price discrimination.
Ideally, firms would like to charge each consumer the maximum or reservation price that they could afford. Doing so would eliminate consumer surplus because each consumer would be paying exactly what they"d be willing to pay, therefore the price of the good/service would no longer prevent anyone from being able to purchase it. This type of discrimination is also known as first-degree discrimination and is considered to be ideal for firms. .
First degree discrimination is great in theory, however is unpractical in application. How is a firm supposed to know exactly how much each consumer is willing to pay? It is virtually impossible to predict everyone's reservation price with absolute certainty -- with the obvious exception being a very small market. First degree policies are used in markets nevertheless, because "firms can discriminate imperfectly by charging a few different prices based on estimates of reservation prices. This practice is often used by professionals, such as doctors, lawyers, and accountants that know their client particularly well" (Pindyck, 373).
Price discrimination can also be achieved by charging different prices based on different quantities of a good or service. This discrimination, also known as second degree discrimination, is often witnessed in wholesale purchases of products.
