The text describes three different “degrees” of price discrimination.

The text describes three different “degrees” of price discrimination.

Of these, which one is theoretically capable of generating the greatest amount of economic profit for the firm? Why? In contrast, which one do you think has the greatest applicability to the range of goods and services consumers typically purchase?

ANSWER

Because its goal is to charge the maximum willingness to pay for each unit of a good sold, first-degree price discrimination has the potential to generate the greatest amount of profit for the firm. In effect, first-degree price discrimination converts all of the surplus that would have been realized by consumers into profits for the firm. However, it is virtually impossible to determine maximum willingness to pay for a specific good. In contrast, third-degree price discrimination results in different prices being charged to different groups of customers based on differences in the price elasticity of demand. Relatively speaking, it is easier to group customers according to common characteristics and to use these characteristics to make educated guesses about price elasticity than it is to determine individual willingness to pay. Finally, second-degree price discrimination is most effective when customers purchase relatively large quantities of a good and these quantities can be divided up into blocks that are priced at different rates. As such, compared to third-degree price discrimination, it is reasonable to argue that second-degree price discrimination is applicable to a more limited range of products.