Evaluate the view that, because price discrimination (PD) enables firms to make more profit, firms, but not consumers, benefit from PD. (25)

Price discrimination enables firms to increase their profits by setting a profit maximising price for different groups of consumers and therefore increase total profits. Customers with inelastic demand, who buy peak priced tickets may have reduced consumer surplus as firms increase prices to them. These customers will lose welfare as they pay a price higher than marginal cost, which is allocatively inefficient.

With price discrimination, the demand curve is divided into the elastic range down to D1 and the inelastic range down to D2. A higher price (P1) is charged to the low elasticity segment, and a lower price (P2) is charged to the high elasticity segment. The total revenue from the first segment is equal to the area P1,B,Q1,O.

The total revenue from the second segment is equal to the area E,C,Q2,Q1. The sum of these areas is always greater than the area without discrimination (see the upper diagram). Where more prices are introduced the value of the revenue area rises, and more of the consumer surplus is captured by the producer.

This profit can benefit consumers too; firms may use it to fund R&D. This enables dynamic efficiency and consumers benefit from better quality products and services in the long term; very important in industries like pharmaceuticals where a lot of investment is needed.

Another potential benefit of profit is that it might enable a firm to stay in business. By gaining more revenue as a price discriminator the firm is able to make sufficient profits to stay in the industry which might not have be the case had they only been able to charge one price. Although some customers pay a higher price they have a service where otherwise there might be none, a clear improvement.

Some customers may benefit if the higher prices paid by inelastic customers subsidise lower prices for other groups of consumer e.g. so the high prices paid by business people travelling at peak time could subsidise lower prices for pensioners say. However, people with inelastic demand (adults travelling at peak time) may have no greater ability to pay (an unemployed person travelling to an interview) than people with elastic demand (e.g. rich pensioners). So whilst price discrimination could enable a fairer distribution of resources in society, it doesn’t seem likely that it would!

So it can be seen that price discrimination provides benefits to some consumers, even those who pay the higher prices. The indirect benefits associated with dynamic efficiency gains are perhaps limited in scope, where supermarkets might deliver such improvements might be more difficult to determine than for a drug company. What seems quite clear is that firms benefit most from the ability to target customers by price.