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How Price Discrimination Can Be a Win-Win For All

May 11, 2019 8:25 AM 4 min read


Ever wondered why platforms like Spotify, GitHub or even Apple give such amazing student discounts. Ever wondered why VIP stand tickets for a live game are exorbitantly priced, even though the game looks pretty much the same from all sides (apart from a few nuances, of course). 


These are all real - world examples of "Price Discrimination".


What is Price Discrimination?


Price discrimination suggests selling the same product or service to different groups of buyers at different prices.


An Illustration


Let’s say you applied to MIT, and you get through (Well Congrats!). You would notice that MIT offers financial aids and scholarships to many students, while you have to pay the full fees (assuming that you are not receiving any of those aids). Now what might come across as unfair to you might in fact be a win-win for all.


Consider this, a very deserving candidate, Jagmohan, gets through MIT, but cannot afford the college fees. He is highly sensitive to the price - a crucial factor determining his decision to whether to join the college or not. Under such circumstances, the institution offers him a discount. Had MIT not exercised this price discrimination, Jagmohan would have never joined the institution. MIT would have been deprived of whatever amount he was willing to pay, and even more, lose out on a deserving candidate.


You, on the other hand are less sensitive to the price, willing to shell out a few extra bucks if that's what gets you into the premium institute. 


Therefore, while without price discrimination, only you would have paid MIT, it now gets some amount from Jagmohan as well. In a similar fashion, companies all over the world use price discrimination to maximise their profits.


Price discrimination basically charges each consumer his/her maximum willingness to pay and spreads the fixed cost over a larger number of customers. It helps a company efficiently maximize its profits.



How Price Discrimination Can Be a Win-Win For All 

But is it beneficial for the customers? Well yes, it is!


As we can see in the above example, more students will attend MIT (both you and Jagmohan) than otherwise would have been the case. Likewise, more students are able to attend college in general, as most universities undertake this practice. Everyone in the customer base is more or less happy to pay the price they’re paying, which would not have been the case if the price of a commodity or service was same for all the customers. One size cannot fit all.


But is it Always Easy for Companies to Price Discriminate?


In the above example, education is a service, which is easy to price discriminate. But this is not the case when it comes to commodities (manufactured goods).


If a company price discriminates over a particular commodity in two different markets, it is highly likely that there will be a lot of people who will purchase the commodity in the lower price market, and sell it in the higher price market, earning a profit from the difference. This practice is known as Arbitrage.


This would ultimately force the company to sell the commodity at a global price. In such a scenario, it will abandon the lower price market and cater to the higher price market only.  A unpleasant scenario for both the people in the lower price market as well as the company at large. Hence, to avoid arbitrage, companies take certain measures.


Another interesting example coming your way!


Pronix solutions produces a compound called ASD which has applications in two sectors - chemical plants and Orthodontology. It is the case that larger quantities of ASD is required in chemical plants than in dental clinics. Furthermore, while chemical plants can use one of its many available substitutes, ASD has very few substitutes in Orthodontology. Subsequently, dentists are willing to pay a higher price for ASD vis-a-vis chemical plants.


Leveraging this demand, Pronix solutions sells ASD to dentists at Rs.100 per pound, whereas they sell the same product to the chemical plants at a mere Rs. 10 per pound. But what if the dentists start going to the same market as chemical plants and buy ASD at Rs.10 per pound? Or what if entrepreneurs start buying industrial ASD, distil it to ASD for clinical use, and sell it at a higher price? To avoid this, Pronix solutions poisons the industrial ASD, so that it cannot be used in clinics. Similarly, the government poisons certain goods such as ethanol or fuel to prevent arbitrage.


Is Price Discrimination Legal?


Yes, it is, if not done on the basis of race, religion, nationality, or gender, and if it is not in violation of any antitrust or price-fixing laws.


Next time you feel resented that you have to pay more than Jagmohan, it may perhaps be simply because you can. Charging "poor" customers less while still making profits by charging the “richer” ones may not inhumane, it might just be a good pricing strategy.


Originally published here.


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