What it means
A monopoly has no close competitors, so it has the power to set prices. A plain monopoly charges one price to everyone, and it has to choose between a high price that excludes some buyers and a low price that leaves money on the table.
A discriminating monopoly escapes this trap by splitting its customers into groups and pricing each one separately. For this to work, three conditions are needed.
The seller must have market power, must be able to tell groups apart by their willingness to pay, and must stop the lower-priced buyers from reselling to the higher-priced ones. Without those, the discount customers would simply undercut the seller.
Everyday examples include student and senior discounts, different prices for business and leisure travellers, and lower prices for the same drug in poorer countries. Utilities and software vendors often use tiers and volume discounts.
In each case, the seller charges more to those who value the product highly and less to those who would otherwise not buy at all. The finance impact is higher revenue and profit than a single price would deliver, because more customers are served and each pays closer to their limit.
The cost is complexity, since the business must manage several prices and guard against resale. Customers who feel they are being treated unfairly can also react badly, so many firms explain the differences carefully.
The nuance for policy is that price discrimination is not automatically harmful. It can make a product available to people who could not afford the single price, but it can also be used to extract the maximum from captive buyers.
Competition laws in many countries therefore examine it case by case. Digital markets have made the practice easier.
Online sellers can see location, device, purchase history and timing, and use that information to tailor offers, which gives even small firms tools once available only to large ones. This has raised questions about transparency, because customers may not know that someone else paid less for the same item.
In practice
Real-world examples.
Example
A regional airline is the only carrier on a remote route. It charges business travellers booking at short notice $600 and holidaymakers booking early $180. Both groups fly, and the airline fills its seats at better revenue than a single fare would achieve.
Example
A pharmaceutical company holds the only patent on a treatment. It sells at a high price in wealthy countries and at a much lower price in poorer markets. The lower price still covers the cost of production and brings in additional revenue.
Example
A local cinema is the only one in a small town. It offers cheaper tickets on weekday afternoons and for pensioners, and charges full price on Saturday nights. Seats that would have been empty now earn some revenue.
Formula
Calculation
Profit = sum over groups of (price - unit cost) x quantity sold to that group
A monopolist has a unit cost of $40. Group A has 600 buyers who will pay up to $120 and Group B has 400 buyers who will pay up to $60. With a single price of $120, only Group A buys, so profit = 600 x ($120 - $40) = 600 x $80 = $48,000. With price discrimination, Group A pays $120 and Group B pays $60, so profit = $48,000 + 400 x ($60 - $40) = $48,000 + $8,000 = $56,000. The extra $8,000 comes from serving customers a single high price would have lost.Case study
Seen in the real world.
Granite Peak Software is an illustrative, fictional company that sells the only specialist tool for managing mining equipment. It originally charged a single licence fee of $12,000 and sold to 500 large mining companies, earning $6,000,000.
The new sales director suggested a basic version for small operators at $4,000 and kept the full version at $12,000. Another 700 small operators bought the basic version, adding $2,800,000, and only 40 large buyers switched down to it, costing $320,000 in lost revenue.
The net revenue gain was $2,800,000 - $320,000 = $2,480,000. The illustrative lesson is that careful product tiers can reach new customers while protecting the high-value base, though the company must watch for large buyers switching to the cheaper option.
Watch out
Common mistakes.
- Assuming any business that charges different prices is a monopoly, when many competitive firms also use price discrimination.
- Ignoring the risk of resale, which can destroy the strategy if cheaper buyers can sell to those paying more.
- Treating price discrimination as always unfair, when it can enable access for customers who could not afford a single high price.
Questions
People also ask.
What are the conditions for price discrimination?
The seller needs market power, a way to separate customers by willingness to pay and a means to prevent resale between groups.
Is price discrimination legal?
Often yes, but it depends on the country and the circumstances, and competition regulators look closely at cases involving dominant firms.
How is it different from a normal monopoly?
A normal monopoly sets one price for everyone, while a discriminating monopoly sets several prices to capture more from each group.
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