Second Degree Price Discrimination

Second Degree Price Discrimination

Many companies may practice second-degree price discrimination without realizing it by offering volume discounts or charging more for higher quality products or services. To determine what second-degree price discrimination is in real-world settings and to identify appropriate examples of the practice, this paper reviews the relevant literature concerning second-degree price discrimination, followed by an analysis of its important aspects from an economic theoretical perspective. An examination concerning how producers discriminate between different types of consumers is followed by a discussion concerning welfare implications in the example and the potential role for governments to regulate this practice. A summary of the research and important findings are presented in the conclusion.

Review and Discussion

Whenever companies offer their products or services at a discounted price for volume purchases or set higher or lower prices depending on the quality of those goods or services, they are practicing second-price discrimination. For instance, according to Burkett, "A firm practices second-degree price discrimination or indirect price discrimination when it sets a price schedule under which the unit price paid by a buyer depends on the quantity or quality purchased by the buyer, with prices not proportional to unit cost" (2006, p. 161). This observation means that companies may charge less per unit for larger volume purchases but they may charge higher prices for fewer unit purchases. Likewise, companies may command higher prices for higher quality in the second degree price discrimination model. In this regard, Burkett cites a useful example of how such practices are used by the airline industry: "Quality-based discrimination can rely on quality differences in consumption or purchasing. Quality differences in consumption are important to airline pricing. Airline tickets are often cheaper when subject to restrictions such as advance purchase and Saturday night stay-overs" (2006, p. 161). This observation indicates that the "quality" of the ticket is diminished by virtue of these restrictions despite the fact that the "quality" of the actual flying experience remains essentially the same, but for good reason. As Burkett points out, "These restrictions are designed to be more inconvenient for business travel than personal travel. Business travelers, with a low price elasticity of demand, are thus induced to buy expensive unrestricted tickets, while personal travelers, with higher price elasticities, rearrange their lives to use cheaper restricted tickets" (2006, p. 161). Some authorities suggest that charging heavy users of a product or service more also represents a type of second degree price discrimination (Carroll & Coates 1999).

While second degree price discrimination is practiced in a wide range of industry (Wilson 1993), critics cite the adverse effects it may have on general welfare. In this regard, Carroll and Coates emphasize that, "Although this profitable behavior may be 'efficient' for the firm (i.e., privately efficient) it is not socially efficient" (1999, p. 466). Likewise Wilson (1993) suggests that governmental agencies may not support the offering of differential price schedules because such practices may place some consumers at a disadvantage.