Solution:

Types of Price Discrimination:

• There are many forms of price discrimination, but the standard method of classification identifies three types or degrees of discrimination,

(1) First-degree price discrimination.

(2) second-degree Price Discrimination.

(3) Third-degree price discrimination.

• But there are other two types also named as,

(1) Price Skimming.

(2) price Combination.

-Their common characteristic is that they allow the firm to capture part of the consumer surplus that would have resulted from uniform pricing.

Third-degree price discrimination:

• In third-degree price discrimination, price varies by attributes such as location or by customer segment, or in the most extreme case, by the individual customer's identity; where the the attribute in question is used as a proxy for ability/willingness to pay.

• Additionally to third-degree price discrimination, the suppliers of a market where this type of discrimination is exhibited are capable of differentiating between consumer classes. Examples of this differentiation are a student or senior discounts.

• For example, a student or a senior consumer will have a different willingness to pay than an average consumer, where the reservation price is presumably lower because of budget constraints.

• Thus, the supplier sets a lower price for that consumer because the student or senior has a more elastic price elasticity of demand (see the discussion of price elasticity of demand as it applies to revenues from the first-degree price discrimination, above).

• The supplier is once again capable of capturing more market surplus than would be possible without price discrimination. Note that it is not always advantageous to the company to discriminate against price even if it is possible, especially for second and third-degree discrimination.

• In some circumstances, the demands of different classes of consumers will encourage suppliers to simply ignore one/some class(es) and target entirely the other(s). Whether it is profitable to discriminate is determined by price by the specifics of a particular market.

Third Degree (Multi-Market) Price Discrimination:

• This is the most frequently found form of price discrimination and involves charging different prices for the same product in different segments of the market.

• The key is that third-degree discrimination is linked directly to consumers' willingness and ability to pay for goods or services.

• It means that the prices charged may bear little or no relation to the cost of production.

• The market is usually separated in two ways: by time or by geography.

• For example, exporters may charge a higher price in overseas markets if demand is estimated to be more inelastic than it is in home markets. MC=AC

• Suppose a firm has separated a market by time into a peak market with inelastic demand, and an off-peak market with elastic demand. The demand and marginal revenue curves for the peak market and off-peak markets are labeled A and B respectively.

• This is illustrated in the diagram above. Assuming a constant marginal cost for supplying to each group of consumers, the firm aims to charge a profit-maximizing price to each group.

• In the peak market, the firm will produce where MRA = MC and charge price Pa, and in the off-peak market, the firm will produce where MRB = MC and charge price Pb.

• Consumers with inelastic demand for the product will pay a higher price (Pa) than those with an elastic demand who will be charged Pb.