The practice of charging different prices to different consumers, for the same goods, where the price differences do not reflect differences in cost of supply. In order to practise any form of price discrimination it must be possible to prevent arbitrage, since otherwise buyers at a lower price could resell to buyers at a higher price and both parties would gain, which would undermine the price discrimination. 'Perfect' price discrimination exists when each buyer is taken separately and is charged the maximum he is prepared to pay for each unit of goods. In this way the seller appropriates all the consumer surplus. In practice, perfect price discrimination is rarely feasible, and instead buyers are divided into broad groups on the basis perhaps of income, location or type of economic activity ('domestic' versus 'industrial' consumers). Provided the elasticities of demands of the groups differ (and a major purpose of the division into groups will be to isolate such elasticity differences), a profit-maximizing seller will charge different prices to the groups, setting a higher price to a group with a lower elasticity of demand. A firm practising price discrimination will earn a relatively greater profit margin in more or less captive markets and a lower margin in more competitive markets.
|Reference: The Penguin Dictionary of Economics, 3rd edt.|