Types and Examples of Price Discrimination in a Monopoly

Updated July 9, 2022

A monopoly is a type of market structure where a single organization controls the largest portion or entire market share of certain goods and services. Monopolists can also control the price of the goods and services in the market. Understanding monopoly price discrimination can help you learn how monopolists manage their pricing strategy. In this article, we define price discrimination in a monopoly, discuss types and examples of price discrimination, explore why monopolies use price discrimination, and explain the steps to implement price discrimination.

Related: What Is a Competitive Price? Understanding Pricing Strategy

What is price discrimination in a monopoly?

Price discrimination in a monopoly is a practice of charging different prices for the same product. Monopolies usually have more control over suppliers than regular sellers, which means they can significantly influence the suppliers' selling prices. Monopolists can also set higher prices to increase profit when the supply is low. They require suppliers to cooperate with them to help manage costs and increase gains. For example, when companies purchase intermediate or raw materials from suppliers in different markets, it can lower prices for consumers.

Price discrimination may also allow businesses to earn higher profits at the expense of some consumers. Setting low prices ideal for target customers can make other consumers pay more than they might for the same goods and services under perfect competition. Monopolists use this strategy to sell the same products at different prices to different consumers. This may increase a monopolist's market power because it can help the firm profit more than its competitors, setting uniform prices for a product or service.

Related: What Is Loss Leader Pricing? (With Advantages and Tips)

Benefits of price discrimination in monopoly

Here are some ways price discrimination can benefit monopolies:

Increases profit

Price discrimination typically helps increase the monopoly firm's profit by maximizing its total revenue. A monopolist charges some customers higher prices rather than a uniform fee for all buyers. Price discrimination among customers with inconsistent demands can minimize the risk of setting up a uniformly high price. A high price may mean that only a few customers can afford a product or service. Monopoly firms can charge higher fees to infrequent customers to increase the total revenue.

Increases customer satisfaction

Customers usually associate a higher price with an excellent customer experience. Price discrimination may increase buyers' loyalty because the firm can charge different prices for each of them, giving a few premium experiences. It can also encourage customers to shift towards a monopoly product or service over alternative products because they get more satisfaction.

Concentrates on core market segments

Price discrimination encourages monopolists to focus on marketing their products and services towards specific groups of people. It is usually more efficient than working to fulfil everyone's expectations in the market. Price discrimination is a strategy firms can use to improve their total revenue, profit, and productivity. It often leads to market segmentation, minimizes competition, and increases profit.

Increases investments

Price discrimination encourages monopolists to make more investments, like new marketing efforts, to reach their target market. Investment projects can generate more revenue and increase a monopoly's profits. For example, a monopoly can invest in its supply chain logistics to ensure sufficient and timely supply to meet customers' demands.

Empowers consumers

Price discrimination can empower consumers because they may have the freedom to choose what they pay for products. It allows consumers to determine their priorities of price, quality, and other aspects of choice. A monopolist can control the price of its product or service and manage the consumer's demand. For example, they can increase the demand by increasing or lowering the price depending on the situation.

Controls demand

Monopolies also use price discrimination to manage the demand for a product or service. For example, transport services such as taxis can be more expensive during the rush hours to manage demand. They can also offer incentives to encourage customers to travel at different times. For example, they can set lower prices before and after rush hours.

Related: What Is Demand and Supply? (Including How They Work)

Types of price discrimination

Price discrimination can vary depending on different markets. The main types of price discrimination include:

First-degree price discrimination

First-degree price discrimination usually refers to charging the clients the maximum price they can pay for a product or service. It usually covers all individual variations in demand and supply. The effectiveness of first-degree price discrimination can depend on whether the company can accurately determine the maximum price customers are willing to pay. It may be easy to implement in industries where the transactions with the customer are private, such as aviation and hospitality.

Second-degree price discrimination

In second-degree price discrimination, monopolists can charge different prices for their products and services. It is more common in the retail industry, such as buying items in bulk at a discount. Second-degree price discrimination helps monopolies reach a larger part of the market. It may also increase customer loyalty. An example of second-degree price discrimination is when airlines lower the prices for frequent travellers. The price may vary according to the time of purchase.

Third-degree price discrimination

Third-degree price discrimination may refer to a monopoly subdividing an entire market into consumer groups. The submarket groups can vary by age, location, and gender. Monopolists using third-degree price discrimination focus on the choice of the entire group rather than the choice of individual consumers. They charge each submarket differently for a product or service. An example of third-degree price discrimination is lower ticket prices for students than other adults.

Examples of price discrimination

Here are some examples of price discrimination:

Personal price discrimination

Personal price discrimination may refer to price discrimination based on the individual characteristics of customers. This type of price discrimination depends on the consumers' income level and willingness to pay for the product. An example of personal price discrimination is different prices for seniors and minors or gender-based prices. For instance, a Ladies' Night event at a bar may set lower prices for all the ladies making purchases during the event.

Geographic price discrimination

Geographical price discrimination can be the difference in a product or service price based on location. It occurs when prices for goods or services are higher in some areas and lower in others. For example, a monopolist can set higher prices for people living in urban areas than rural areas.

Time or seasonal price discrimination

Price discrimination by time or season can refer to charging different rates for different times or seasons. A monopoly can practice this form of discrimination during peak seasons when demand for a product is higher than during the off-season. For example, long-distance phone calls at off-peak hours are cheaper than peak hours because of lower demand and the lack of supply during busy times. An example of a peak season is the holidays, such as New Year's Day.

How to implement price discrimination

You can follow these steps to successfully implement price discrimination in a monopoly:

1. Identify the submarkets

Some consumers may pay a significantly higher price for a product or service than others. Identify and categorize different markets. This type of buyers' segmentation creates a platform for price discrimination. For example, buyers of luxury goods, such as designer handbags, may pay significantly higher than the average buyer for inexpensive goods.

2. Identify the elasticity of demand

The elasticity of demand identifies how responsive customer demand is to changes in price. A price change may significantly impact market demand for a product with low elasticity. Low elasticity may mean customers have greater difficulty finding acceptable substitutes for the product a company produces.

Related: What Is Elastic Demand? (Definition and How to Calculate)

3. Set uniform price

Uniform prices can refer to the standard price of a product or service sold in all markets. Setting a uniform price may allow the customer to easily make a final decision. Setting a uniform price discourages arbitrage, which is the act of making a profit by buying an item for a lower price and later selling it for a higher price.

4. Restrict resale of products and services

Restricting the sale of goods may be necessary to prevent reselling and transfer sales for a product purchased at a lower price to another group. The monopolist may limit the resale of goods to those in a specific market segment. Under rare circumstances, other sellers may restrict access by charging higher prices for identical goods and services.

5. Reduce competition from rivals

Sometimes, a monopolist may charge different prices for a product to customers in all markets. They can gain an advantage over a company's competitors by setting competitive prices. As a result, rivals may not compete effectively against monopolists, and their profit margins may reduce. Monopoly products have higher profit margins from reduced competition.

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