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In economics first, second and third degrees of discrimination refers to the different ways in which different customers may be charged different prices for an identical product. These terms were first coined and defined by Arthur Cecil Pigou (1877-1959).
In first degree discrimination, each customer is charged a price which is exactly equal to the the value of the product for that customer. IN this type of pricing the seller gets maximum revenue, while the purchaser benefit is exactly equal to the price paid. Thus there is no surplus benefit to the customers. This type of pricing is only a theoretical concept. It does not exist in reality because of difficulty and cost of ascertaining the value of the product for each customer. Also the customer has no incentive to buy the product in absence of any surplus benefit.
Second degree price discrimination involves charging different prices to different customer or at different times depending upon the consideration of sellers costs and ability. The most common form of second degree price discrimination is the quantity discount. A company's cost on bulk sale are lower than those for sale in smaller quantities,. therefore most of the companies offer lower prices or a discount for purchase in larger quantities.
Other common second degree price discrimination include very low prices charged by airlines for tickets sold just a short time before departure of flights. This is because airline incur no significant extra cost on those passenger, and if they are not able to get passengers at full price, they are still better off selling tickets at heavily subsidized rates. Other common example of this type of pricing is different rated charged by hotels at different times of the year, and happy hour discounts offered in restaurants during lean period of the day.
Third degree discrimination involves charging different prices to different segments of customers. This method of price discrimination is really an imperfect variation of the perfect type represented by first degree price discrimination. In this methods different segments of customers are identified and each segment is charged price base on what price is most profitable for the company in each segment. The most common way of segmentation for this type of price discrimination is by geographic location. A very prominent example of this type price discrimination in charges for operations by surgeons. For the same type of operations surgeons and hospitals charge different fees depending on the type of hospital room and other facilities that the patient chooses during hospitalization for operation. Other common form of such price discrimination include discounts such as those for students or senior citizens.
Third Degree Discrimination in economics has to do with a company's pricing policy. If a business engages in third degree price discrimination, then they are charging different groups of people different prices for the same product. The prices for each group are discriminatory because they are based on race, sex, ethnicity or location.
This type of pricing strategy is often viewed as providing a service to the community for example, when Senior citizens are charged a lower price because of their age, it is viewed as giving them a break.
But third degree price discrimination often results in higher profits.
For a detailed explanation, including equations to explain the different price discrimination theories, click on the links below and look through the pages of both books.
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