In this article we will discuss about the three degrees of price discrimination.
First Degree Price Discrimination:
If the monopolist charges a customer, for each unit of his product, a price that the latter is willing to pay in accordance with the level of utility derived by him from that unit, i.e., if the monopolist charges a price for any unit, which is equal to the marginal utility obtained by the customer, then he would be said to practice first degree price discrimination.
In this case, owing to the law of diminishing marginal utility, the price that the monopolist would charge the customer for the marginal unit of his purchase would be diminishing as the customer buys more and more of his product.
For example, if the customer is willing to pay Rs 25, Rs 23 and Rs 20, respectively, for the first, second and third unit of his purchase, and if the monopolist also charges him Rs 25 for the first unit, Rs 23 for the second unit and Rs 20 for the third unit, then it would be a case of first degree price discrimination.
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Here the consumer is getting a total utility of Rs 68 (= Rs 25 + Rs 23 + Rs 20) and the monopolist is also charging the consumer Rs 68 for these three units. Therefore, the consumer’s surplus in this example would be total utility obtained – total expenditure of the consumer = Rs 68 – Rs 68 = 0.
It is clear from above that in the case of first degree price discrimination, the monopolist sets the prices of different units of his product purchased by a consumer in such a way that the consumer’s surplus may become equal to zero.
Second Degree Price Discrimination:
In the case of second degree price discrimination, the monopolist seller charges a buyer of his product a price for the first few units, which is equal to the buyer’s marginal utility for that quantity, then he charges the buyer for the second group of a few units a price which is equal to the marginal utility of that quantity, and so on.
For example, if the buyer derives levels of utility equal to Rs 30, 28, 26, 24, 22 and 20, respectively, from the first six units of the product and if the monopolist sets for him the price of Rs 26 for the first three of these units and the price of Rs 20 for the next three of these units, then we may say that the monopolist is practising the second degree price discrimination.
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In this case, from the first three units, the consumer is getting consumer’s surplus of Rs [30 + 28 + 26 – 26 x 3], i.e., of Rs 6 and from the next three units, he is getting a consumer’s surplus of Rs [24 + 22 + 20-20 x 3], i.e., of Rs 6.
That is, from the six units of the product, the consumer is getting a total of Rs 12 of consumer’s surplus. On the other hand, for all the six units, the MU is Rs 20, which the consumer is ready to pay as the price if he is to buy these units.
Now, if the monopolist set Rs 20 as the price of all the six units, i.e., if he did not discriminate between the units with respect to price, then the consumer’s surplus would have been equal to Rs [30 + 28 + … + 20 – 20 x 6] = Rs 30, which is greater than Rs 12.
It is clear from this example that by means of second degree price discrimination also, the monopolist takes away a portion of consumer’s surplus from the buyer of his product, though not 100 per cent of this surplus as in the case of the first degree price discrimination.
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It is obvious from our discussion of the first and second degree price discrimination that in both these cases, the seller has to know the amounts of utility that a consumer derives from the different units of the commodity, i.e., he has to know the individual demand curve of the buyer, and all these he would have to know for all the buyers of his product, which is almost impossible. Not only that.
In these two cases, the seller would have to follow different price policies for different buyers, which is also not feasible. That is why the first and second degree price discrimination, as defined above, are only theoretical cases.
In general, they cannot be put into practice. However, the monopolist, for all the buyers, may set a particular price for the purchase up to a particular quantity of his product, then for the next particular quantity (or block of units), he may set another price, and so on.
Price discrimination between the blocks of units of his sales to a customer may be implemented in this way. This is called block pricing. By means of this type of price discrimination also, the seller may increase the total revenue (and, therefore, profit) at any particular quantity of his sales.
Third Degree Price Discrimination:
In the case of third degree price discrimination, the monopolistic seller sets a particular price of his product for a group of one or more customers, irrespective of the quantity purchased, and another price for a second group of buyers, and still another price for a third group of buyers, and so on.
If we consider a group of buyers as forming a sub-market of the monopolist’s product, then the third degree price discrimination would mean discrimination between the different sub-markets w.r.t. price, i.e., here the monopolist charges different prices for his product in different (sub-) markets. Henceforth we shall assume, unless otherwise mentioned that the monopolistic firm practices third degree price discrimination.