Different group prices require market power and workable separation.
Third-degree price discrimination charges different identifiable customer groups different prices for the same service or good, where the difference is not explained by corresponding cost differences. It requires some pricing power, a workable way to separate groups and limits on resale or switching between groups. Different demand responsiveness can make a higher price profitable in the less price-responsive segment, under the usual comparable-cost model. Different prices alone do not prove discrimination: products, costs, timing or quality may differ. Effects on profit, access and consumer surplus can differ across groups.
- The strategy
- Third-degree price discrimination charges identifiable customer groups different prices for a comparable good or service, where corresponding cost differences do not explain the price gap.
- Conditions
- The firm needs some control over price, a way to identify the groups and limits on resale or switching. If adults can freely use cheaper student tickets, the separate prices may not hold.
- Responses
- Under the usual comparable-cost model, a group whose purchases respond less to price can support a higher price. The actual profit effect still depends on each group's response and the costs.
Read the group-pricing accounts
Contribution
Total revenue (TR) minus total variable cost (TVC) is contribution: money left to cover fixed costs. It is not profit until fixed costs are also deducted. If fixed costs stay unchanged, a $40 rise in contribution means a $40 rise in profit.
Group effects
Some buyers may gain access while others pay more. Total welfare and the best possible prices require further evidence.
Costs
Extra tickets create extra variable costs. Checking eligibility and administering separate prices can add costs too; include them when comparing the plans.
| Pricing scheme | Adult P/Q | Student P/Q | TR | TVC | Contribution |
|---|---|---|---|---|---|
| Common price | 10 / 30 | 10 / 10 | 400 | 160 | 240 |
| Segmented | 12 / 25 | 8 / 20 | 460 | 180 | 280 |
Worked example: Adult and student ticket prices
A venue sells the same unused-seat performance service to adults and verified students at the same $4 variable cost per ticket. Student admission requires verified eligibility, and student tickets cannot be resold to adults. At a common $10 price, adults buy 30 tickets and students 10. A proposed $12 adult/$8 student price sells 25 adult and 20 student tickets. Fixed costs are unchanged.
- At the common price, revenue is $400 and variable cost $160, giving contribution $240 before unchanged fixed cost.
- With the separate prices, revenue is 25 x 12 + 20 x 8 = $460. Variable cost is 45 x 4 = $180, giving contribution $280. Profit is therefore $40 higher under the stated responses.
- Some students gain access through a lower price, while adult buyers face a higher price and fewer adults attend. The group effects differ.
- This proposed scheme beats the specified common-price alternative. It does not prove the prices are globally optimal or establish the total welfare change without willingness-to-pay and other information.
Watch out for this
Every price difference is third-degree discrimination.
Check whether the service and relevant cost are comparable and whether prices differ by identifiable groups.
Check your understanding
A company charges more for a larger, more costly premium product than a basic version. Is this fact alone enough to establish third-degree price discrimination?
- No; product and cost differences must be considered.
- Yes; any two prices prove discrimination.
- Yes, provided the company is profitable.