This week’s article focuses on price discrimination. It higlights the importance of the main economic motives for price discrimination under the Fiji Commerce Commision Decree(2010) and restrictive trade practice.
What Is Price Discrimination?
Price discrimination exists when two “similar” products which have the same cost are sold by a trader at different prices. That is charging different prices to different customers for the same product and with the same cost. This article aims to explain some of the main economic motives for price discrimination, and to outline when this practice will have an adverse or beneficial effect on consumers, business and on total welfare.
Price Discrimination under CCD2010
Section 71 of CCD2010 restricts a trader from engaging in any conduct relating to supply of identical goods or services to different players that has an effect of lessening competition via discriminatory practices in terms of: • The prices charged for the goods; • Any discounts, allowances, rebates or credits given or allowed in relation to the supply of the goods;
• The provision of services in respect of the goods; or • The making of payments for services provided in respect of the goods.
For instance, price discrimination can be observed in the following case. Assume Company A supplies bottled water in wholesale quantities to various retailers in a market. The ex-factory cost of a 1.5 litre bottled water is $1.00 and the normal wholesale price is $1.50 per 1.5L bottle. Retailers A and B are competitors located in the same geographical market. Company A and Retailer A enter into an understanding to trade a 1.5 litre bottled water at $1.10 whereas the normal price of $1.50 is applied to Retailer B.
In this instance Retailer B will be at a competitive disadvantage compared to retailer A in terms of the retail prices. Given the huge discount per bottle offered to Retailer A, the competition for bottled water in this geographical market will be lessened due to discriminatory wholesale prices. A conduct may not be considered price discriminatory if the price variances can be explained by differences in the cost of serving different consumers such as cost of manufacture, distribution, sale or delivery resulting from the differing places to which, methods by which or quantifies in which the goods are supplied to the purchasers. For example, consumers who pay higher insurance premiums or higher insurance rates may be more risky and thus more costly to supply than consumers who pay lower rates. Secondly it is not an act of price discrimination if the discrimination is constituted by an act in good faith to meet a price or benefit offered by a competitor of the supplier. The onus of proving that a trader business has not engaged in conduct of price discrimination is on the business suspected to have engaged in the said conduct under CCD2010.
There are three main reasons why competition policy may be concerned with price discrimination.
• Firstly, a dominant firm may “exploit” final consumers by means of price discrimination, with the result that total and/or consumer welfare are reduced.
• Secondly, it is sometimes a policy objective to attain a “single market” across the region. Arguably, one manifestation of a single market is that a firm does not set different prices in different regions, or at least it does not prevent arbitrageurs reselling goods sourced in the low-price region to the high-price region. That is to say, firms are often prevented from segmenting markets with a view to engaging in price discrimination.
• Lastly, perhaps most importantly from a competition authority’s point of view, the authority may be concerned that price discrimination can be used by a dominant firm to “exclude” (or weaken) actual or potential rivals.
Levels of Price Discrimination
In most markets, businesses set the charges for purchase of their products by means of a simple price per unit for each product, where these prices do not depend on who makes the purchase. Such prices : (i) are anonymous (they do not depend on the identity of the consumer)
(ii) do not involve quantity discounts for a specific product, and
(iii) do not involve discounts for buying a range of products. The following are three general levels of price discrimination.
First-degreeprice discrimination or perfect price discrimination,
means that the seller sells each unit of the good at the maximum price that anyone is willing to pay for that unit of the good. Alternatively, perfect price discrimination is sometimes defined as occurring when the seller makes a single take-it-or-leave-it offer to each consumer that extracts the maximum amount possible from the market. For example: This can best be seen in car dealers, where the price on the car is negotiable, and the dealers job is to get the most out of the consumer as possible.
Second-degree price discriminationor non linear price discrimination
, occurs when individuals face non-linear price schedules, i.e. the price paid depends on the quantity bought. The standard example of this form of price discrimination is quantity discounts.
Third-degree price discrimination
based around the idea that the firm sets prices that will accommodate the consumer. The firms know broad demographics about the particular types of consumers they will supply, and charge prices such that everyone will be able to consume the product.
Forms of Price Discrimination Non-anonymousprice discriminations
This occurs when a firm offers a different tariff to identifiably different consumers or consumer groups. Examples of this practice include selling the same drug at difference prices for human and animal use. Unless arbitrage between consumer groups is very easy or competition between firms is almost perfect, we expect that any firm, if permitted to do so, would wish to set different tariffs to different groups.
This occurs when the per-unit price for a specific product decreases as the number of purchased units increases. This role for nonlinear pricing exists even if all consumers are similar. These includes rebates, discount coupons, bulk and quantity pricing, seasonal discounts, and frequent buyer discounts which effectively reduces the cost per unit.
This occurs when the price for one product is reduced if the consumer also buys another product. Two variants of bundling exist:
Is where a consumer can only purchase the products as bundle and there is no scope for buying an individual item. It forces some consumers to purchase products for which their willingness-to-pay is smaller than the cost of supply. In addition, we will see that pure bundling can provide a means by which to deter entry by single-product firms.
Is where the firm sets prices for a bundle and also for individual items. Mixed bundling (with two products) sorts consumers endogenously into three groups: those with a strong taste for both products (who buy the bundle from the firm), those with a strong preference for product 1 but weak preferences for product 2 (who buy just product 1), and those with the reverse tastes (who buy just product 2).
Negative Effects of Price Discrimination on Consumers and Business
The effects of price discrimination are multiple, complex and highly dependent on the competitive environment in which firms operate.
• Price discrimination benefits businesses through higher profits. A discriminating monopoly is extracting consumer surplus and turning it into supernormal profit.
• Price discrimination can also be used as a predatory pricing tactic to harm competition and increase a firm’s market power. This can be beneficial to the producers employing price discrimination; however, other producers may be forced out of the market, undercut by the low prices offered by the firm practicing price discrimination. This can result in inefficiency in the long term as producers gain monopoly power and become inefficient due to the lack of competition. • Lessens competition and consumer choice. Next Week: Anti-Competitive Conduct