Pricing is a basic and interesting topic in the bu
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Pricing is a basic and interesting topic in the business. This paper will be described the strategy of setting prices for products and services; especially it will focus on one specific strategy called price discrimination, which is to charge different prices to different customers for the same or similar product and service. Price discrimination is one of the most effective strategy to maximize a company's profits when compared with a single pricing. However, it represents a transfer of value from consumers to companies and people may argue it benefits less to customers than to companies. In the following, three types of price discrimination will be described, and real examples will be used to illustrate them. The advantages and disadvantages of price discrimination as well as its benefit to consumers and society will be discussed.
The first type of price discrimination
The first type of price discrimination is based on two concepts: reservation price and consumer surplus. For a product and service, the reservation price is defined as the maximum price that a customer is willing to pay (Pindyck & Rubinfeld, 2001, p.371), and the consumer surplus is difference between the reservation price and the price the consumer actually pays (Hubbard & O'Brien, 2012, p.98). The goal of the first type of price discrimination is to capture the consumer surplus and turn it into its profit for a company.
For example, a tea shop sells a good brand of tea. For a cup of the tea, the competitive price (offered by many competitive suppliers) and the monopoly price (offered by few dominant suppliers) are $3.50 and $4 respectively. It is supposed that there are three customers to buy the tea, and the reservation price of these three customers are $6, $5 and $3.5 respectively. Based on the competitive market price ($3.5), their consumer surplus would be $2.5, $1.5 and $0 respectively. By using the first type of discrimination, the tea shop can ask different prices to these three customers which is $6, $5 and $3.5. By doing so the shop will sell three cups of the tea, and all consumer surplus ($4) would be captured. However, if the shop sets a single price $4, then it can only sell two cups of tea, and the third customer would be eliminated from service. Therefore, not only the profit is reduced but also the number of customers served is reduced as well.
Although it sounds great that a company can increase their profits and the quantity of products sold as well as the number of customers serviced, in practice it is hard to conduct. There are two reasons: first, it is difficult to know each customer's reservation price; second, in order to know customer's reservation price, companies need a lot of efforts in marketing research and investigation, which adds extra cost to the product and then reduces the product's profit. Therefore, it is more suitable for some professional people such as dentists, lawyers and accountants, as they know their customers relatively well. For example, a lawyer may offer a reduced service fee to low-income client, but may charge a higher service fee to upper-income clients as they have the ability to pay. The possible problem is some customers who pay higher price may object price discrimination and argue that it represents a transfer of consumer surplus from customers to companies, which benefits less to customers than to companies such resulting an unfairness to rich people.
The second type of price discrimination
A company can discriminate prices according to the quantity purchased. The practice of setting different prices per unit for different quantities is called the second type of price discrimination or "block" pricing (Pindyck & Rubinfeld, 2001, p.374).
There are many companies who use this type of price discrimination such as grocery stores, suppliers of electricity, water and natural gas. For example, for electric power, consumers are charged different price per kilowatt depending on the quantity consumed. It's usual, as an instance, the first 100 kilowatts of electricity consumed are charged at a higher rate, and after the first 100 kilowatts, consumers are charged at a lower rate per kilowatt.
This price strategy allows a company to convert part of consumer surplus into producer's profit, and at
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