Price discrimination occurs when a seller charges different prices to different customers for the same product. The seller is trying to get the highest price possible for the product. Price discrimination may occur on an individual customer basis, where each customer is charged a different price. It can also happen when groups of customers are charged different prices.
Groups are based on certain characteristics such as international or domestic, educated or uneducated, employed or unemployed, wealthy or poor. There is no limit to the types of groups a company may define for its customers.
There are three degrees of price discrimination. The first is when a seller tries to get the highest price from each customer. The second is when a discount is offered for bulk purchases. The third is when groups of customers are charged different prices for the same product.
Sellers split customers into groups because group profits are higher than when customers are looked at as one homogenous population. How long the seller is able to keep up price discrimination will depend on the elasticities of the groups or sub-markets (also called market segments). Profits in an inelastic sub-market should not change since those consumers are willing to pay a higher price. This is likely due to the lack of alternatives in the sub-market. It is just the opposite for consumers in an elastic market. Due to alternatives, consumers will find substitutes when prices rise, reducing the seller’s profits in that market.
Those companies that are a monopoly are able to more effectively employ price discrimination. Also, it is important that a seller’s sub-markets do not overlap. Otherwise, customers within one group would be able to sell products at a higher price to other groups (who were charged more for the same product).