price discrimination case study

The economics behind Uber’s new pricing model

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Uber is changing the way it calculates fares , moving to a system that charges what customers are “willing to pay”, based on factors like whether you are travelling to a wealthy suburb. But while this change has been met with mild outrage , it is actually a very common practice called “price discrimination”.

Price discrimination is a firm’s attempt to capture the difference between the value a consumer puts on a product and how much they actually pay. Firms do this by charging different prices to different consumers and exploiting differences in willingness to pay.

While this sounds like it comes at the expense of consumers, economic theory shows that society as a whole can benefit if certain conditions are met. For example, if Uber’s new pricing means it can enter new markets or reduce customer waiting times, price discrimination could increase society’s overall welfare.

Price discrimination takes many forms, such as Coca-Cola’s infamous vending machines that increase soft drink prices as the outside temperature increases , or charging more for pink razors .

Cheap movie tickets on Tuesdays are another example of price discrimination, as are the different priced tickets at the theatre and concerts . Pharmaceutical companies charge different prices in different countries , and car dealers negotiate and give out discounts .

The airline industry is often regarded as the champion of price discrimination. It price discriminates on almost every aspect of a fare - from the time a booking is made to the type of seat booked, and, of course, the actual route flown.

The only surprise is that Uber hasn’t implemented such a system before now. Its success has, in large part, been driven by a business model that so cleverly mimics a free-functioning market, notably with its “ surge pricing ”.

What is price discrimination?

Price discrimination is the practice of charging different “types” of consumers different prices for the same product or service.

Broadly, “type” might be based on an observable characteristic (age, gender or residency status for example) or some unobservable characteristic that is revealed through the consumer’s actions or preferences (coupon discounts, early bird specials, happy hour deals and so on).

Regardless of the mechanism, the objective is to exploit the different “willingness to pay” (WTP) between consumers and thereby increase profits. WTP describes the maximum amount a consumer would pay for a particular product or service. Given consumers differ in incomes and other circumstances, this presents an opportunity that firms may exploit through price discrimination.

Economists generally refer to three types of price discrimination – first degree, second degree, and third degree.

First degree generates the most profit. It involves each consumer paying the maximum price they are willing to pay and the firm extracting all of their WTP.

With the exception of some internet auctions , pure first degree price discrimination isn’t very common. But we can see versions of it where consumers pay a fixed fee in addition to ongoing fees (such as residential water pricing), and where a single price covers both access and (limited) consumption (such as internet services with data limits). If properly designed, these alternative pricing systems mimic first degree price discrimination by capturing the maximum profit available.

Second degree price discrimination involves providing discounts for bulk purchases. While generally not achieving the same level of profits as first degree, the profits from second degree price discrimination still dominate over simple uniform pricing (where one price is charged to all consumers).

This type of pricing doesn’t require a consumer to necessarily be identified by an observable characteristic, rather they reveal their “type” through their purchases. For example, a consumer who buys a 24-pack of soft drink cans at the supermarket generally receives a discount (per can) over the shopper who buys a single can.

Third degree price discrimination involves selling the same good or service to different segments of a market, based on willingness to pay. This is implemented using some identifiable consumer attribute, such as geography or age. An example would be train operators charging different prices to adults and students.

Price discrimination based on geography

It is this third type of price discrimination that Uber is adopting. Although some customers will object to paying different amounts for the same distance travelled, Uber is certainly not the first company to exploit a geographic dimension when it comes to pricing decisions.

Many other businesses similarly base pricing decisions on location and (implicitly) the WTP of consumers in the markets they serve. For example, cafes, restaurants and bars operating in popular tourist destinations often charge substantially more than similar venues in neighbourhood locations. Although this may, to some extent, reflect higher costs, that typically doesn’t explain the entire difference.

The subtle point is what economists refer to as “ net prices ”, which occur only when price differences for different versions of the same good are not reflected in different costs.

So is Uber’s plan to charge prices according to the customers’ locations something that should cause users to take to the streets in mass protest, or at the very least raise concerns of regulators? Probably not. After all, it isn’t as if Uber is itself a monopoly. There are always taxis as an alternative. But, of course, the taxi industry has always been partial to a little price discrimination itself. It just isn’t as good at it.

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Price discrimination in the online airline market: an empirical study.

1. Introduction

2. background, 2.1. price discrimination, 2.2. previous studies, 2.3. airline tickets market, 3. materials and methods, 3.1. experimental settings, 3.2. the flight data acquisition software, 4. results and discussion, 4.1. data collection, 4.2. data cleaning, 4.3. data inspection, 4.3.1. intra user profile check, 4.3.2. inter user profile check, 5. conclusions and future directions, supplementary materials, author contributions, institutional review board statement, informed consent statement, data availability statement, acknowledgments, conflicts of interest.

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Azzolina, S.; Razza, M.; Sartiano, K.; Weitschek, E. Price Discrimination in the Online Airline Market: An Empirical Study. J. Theor. Appl. Electron. Commer. Res. 2021 , 16 , 2282-2303. https://doi.org/10.3390/jtaer16060126

Azzolina S, Razza M, Sartiano K, Weitschek E. Price Discrimination in the Online Airline Market: An Empirical Study. Journal of Theoretical and Applied Electronic Commerce Research . 2021; 16(6):2282-2303. https://doi.org/10.3390/jtaer16060126

Azzolina, Stefano, Manuel Razza, Kevin Sartiano, and Emanuel Weitschek. 2021. "Price Discrimination in the Online Airline Market: An Empirical Study" Journal of Theoretical and Applied Electronic Commerce Research 16, no. 6: 2282-2303. https://doi.org/10.3390/jtaer16060126

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What Is Price Discrimination?

• How It Works

The Bottom Line

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What Is Price Discrimination, and How Does It Work?

Ariel Courage is an experienced editor, researcher, and former fact-checker. She has performed editing and fact-checking work for several leading finance publications, including The Motley Fool and Passport to Wall Street.

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Price discrimination is a selling strategy that charges customers different prices for the same product or service based on what the seller believes it can get the customer to agree to. In pure price discrimination, the seller charges each customer the maximum price they will pay. In more common forms of price discrimination, the seller segments customers into groups based on certain attributes and charges each group a different price.

Key Takeaways

• With price discrimination, a seller charges different customers a different amount for the same product or service.
• With first-degree discrimination, the company charges the maximum possible price for each unit consumed.
• Second-degree discrimination involves discounts for products or services bought in bulk, while third-degree discrimination reflects different prices for different groups of consumers.

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Understanding Price Discrimination

Price discrimination is practiced based on the seller's belief that customers in certain groups can be asked to pay more or less based on certain demographics or on how they value the product or service in question.

Price discrimination is most useful to sellers when the profit they earn as a result of separating the markets is greater than the profit that they would have earned had they kept the markets combined. Whether price discrimination works and how long the various groups will be willing to pay different prices for the same product depends on the relative elasticities of demand in the sub-markets. Consumers in a relatively inelastic sub-market may pay a higher price, while those in a relatively elastic sub-market pay a lower price.

In applying price discrimination, companies try to identify different market segments, such as domestic and industrial users, with different price elasticities. For example, Microsoft makes its Office 365 software available for a lower price to educators and educational institutions than to other users.

Markets must be kept separate by time, physical distance, or nature of use for price discrimination to be effective. Otherwise, consumers who purchase at a lower price in the elastic sub-market could resell at a higher price in the inelastic sub-market. Companies that dominate a particular market and use price discrimination strategies within their various sub-markets are known as discriminating monopolies .

While price discrimination has a long history, new tools, such as artificial intelligence , are changing the speed and effectiveness with which it is applied. As a 2021 article in the Harvard Business Review noted, "We're in a new era of supercharged price discrimination, made possible by two major scientific and technological trends. First, AI algorithms—often trained on highly detailed behavioral data—enable organizations to infer what people are willing to pay with unprecedented precision. Second, recent developments in behavioral science —often invoked with the tagline "nudge"—provide organizations greater ability to influence their customers' behaviors."

Price discrimination, as it is commonly practiced, is not illegal in the way that discrimination based on race, religion, gender, and similar factors is.

Types of Price Discrimination

There are three types of price discrimination: first-degree or perfect price discrimination, second-degree, and third-degree. These degrees of price discrimination are also known as personalized pricing (first-degree pricing), product versioning or menu pricing (second-degree pricing), and group pricing (third-degree pricing).

First-Degree Price Discrimination

First-degree discrimination, or perfect price discrimination, occurs when a business charges the maximum possible price for each unit consumed. Because prices vary among units, the firm captures all available consumer surplus for itself or the economic surplus. Many industries involving client services practice first-degree price discrimination, where a company charges a different price for every good or service sold.

Second-Degree Price Discrimination

Second-degree price discrimination occurs when a company charges a different price for different quantities consumed, such as quantity discounts on bulk purchases.

Third-Degree Price Discrimination

Third-degree price discrimination occurs when a company charges a different price to different groups of consumers. For example, a theater may divide moviegoers into seniors, adults, and children, each paying a different price when seeing the same movie. This type of price discrimination is the most common.

Examples of Price Discrimination

Many industries, such as the airline industry, the arts/entertainment industry, and the pharmaceutical industry, use price discrimination strategies. Examples of price discrimination include issuing coupons, applying specific discounts (e.g., age-based discounts), and creating loyalty programs for repeat customers.

In the airline industry, for example, people buying airline tickets several months in advance typically pay less than those purchasing at the last minute. When demand for a particular flight is high, airlines raise ticket prices in response.

By contrast, when tickets for a particular flight are not selling well, the airline will reduce the cost of available tickets to try to generate sales and fill any empty seats. Because many passengers prefer flying home late on Sunday, those flights tend to be more expensive than flights leaving early Sunday morning. Airline passengers will typically pay more for additional legroom, too.

Is Price Discrimination Illegal?

The word "discrimination" in price discrimination does not typically refer to something illegal or derogatory in most cases. Instead, it refers to firms being able to change the prices of their products or services dynamically as market conditions change, charging different users different prices for similar services, or charging the same price for services with different costs. Neither practice violates any U.S. laws—it would become unlawful only if it creates or leads to specific economic harm. 

Wouldn't Consumers Be Better Off if Everybody Paid the Same Price?

In many cases, no. Different customer segments have different characteristics and different price points that they are willing to pay. If everything were priced at say the " average cost ," people with lower price points could never afford it. Likewise, those with higher price points could hoard it if they wished to. This is what is known as market segmentation . Economists have also identified market mechanisms whereby fixing static prices can lead to market inefficiencies from both the supply and demand sides.

When Can Companies Successfully Apply Price Discrimination?

Economists have identified three conditions that must be met for price discrimination to occur. First, the company needs to have sufficient market power. Second, it has to identify differences in demand based on different conditions or customer segments. Third, it must have the ability to protect its product from being resold by one customer group to another.

Price discrimination is a widespread practice across many different industries and is often invisible to the consumer. The buyers of a particular product or service may be unaware that the price they are paying is higher or lower than the one the seller is charging other buyers for it.

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Price Discrimination

A pricing strategy that charges consumers different prices for the identical good or service

What is Price Discrimination?

Price discrimination refers to a pricing strategy that charges consumers different prices for identical goods or services.

Different Types of Price Discrimination

1. first degree price discrimination.

Also known as perfect price discrimination, first-degree price discrimination involves charging consumers the maximum price that they are willing to pay for a good or service. Here, consumer surplus is entirely captured by the firm. In practice, a consumer’s maximum willingness to pay is difficult to determine. Therefore, such a pricing strategy is rarely employed.

2. Second Degree Price Discrimination

Second-degree price discrimination involves charging consumers a different price for the amount or quantity consumed. Examples include:

• A phone plan that charges a higher rate after a determined amount of minutes are used
• Reward cards that provide frequent shoppers with a discount on future products
• Quantity discounts for consumers that purchase a specified number of more of a certain good

3. Third Degree Price Discrimination

Also known as group price discrimination, third-degree price discrimination involves charging different prices depending on a particular market segment or consumer group. It is commonly seen in the entertainment industry.

For example, when an individual wants to see a movie, prices for the same screening are different depending on if you are a minor, adult, or senior.

Primary Requirements for a Successful Price Discrimination

For a firm to employ this pricing strategy, there are certain conditions that must be met:

#1 Imperfect competition

The firm must be a price maker (i.e., operate in a market with imperfect competition). There must be a degree of monopoly power to be able to employ price discrimination. If the company is operating in a market with perfect competition, this pricing strategy would not be possible, as there would not be sufficient ability to influence prices.

#2 Prevention of resale

The firm must be able to prevent resale. In other words, consumers who already purchased a good or service at a lower price must not be able to re-sell it to other consumers who would’ve otherwise paid a higher price for the same good or service.

#3 Elasticity of demand

Consumer groups must demonstrate varying elasticities of demand (i.e., low-income individuals being more elastic to airplane tickets compared to business travelers). If consumers all show the same elasticity of demand, this pricing strategy will not work.

Example of Price Discrimination: Cineplex

The Canadian entertainment company, Cineplex, is a classic example of a firm using the price discrimination strategy. Depending on the age demographic, tickets for the same movie are sold at different prices. In addition, Cineplex charges different prices on different days (Tuesday being the cheapest and weekends being the most expensive). The following is a diagram from Cineplex for a movie screening on a Monday.

As indicated in the diagram above, different age demographics face different prices for the same screening. This is an example of third-degree price discrimination.

Price Discrimination in Increasing a Firm’s Profitability

Consider a firm that charges a single price for an apple: $5. In such a case, it would lead to one sale and total revenue of $5:

Now, consider a firm that is able to charge a different price to each customer. For example:

• $5 for the first consumer
• $4 for the second consumer
• $3 for the third consumer, and so on.

In such a situation, the firm is able to increase its revenues by selling to customers who were originally not going to purchase, by offering price = each customer’s willingness to pay. This leads to five sales and total revenue of $5+$4+$3+$2+1 = $15.

As indicated above, price discrimination allows a firm to reap additional profits and convert consumer surplus into producer surplus.

Advantages of Price Discrimination

Advantages of this pricing strategy can be viewed from the perspective of both the firm and the consumer:

• Profit maximization : The firm is able to turn consumer surplus into producer surplus. In a first-degree price discrimination strategy, all consumer surplus is turned into producer surplus. It also ties into survivability, as smaller firms are able to better survive if they are able to offer different prices in times of greater and lower demand.
• Economies of scale : By charging different prices, sales volume is likely to increase. As a result, firms can benefit from increasing their production towards capacity and utilizing economies of scale.

The Consumer

• Lower prices : Although not all consumers are winners, consumers that are highly elastic may gain consumer surplus from the lower prices, due to price discrimination. For example, at a movie theatre, tickets for seniors and children are typically priced at a discount to adult tickets.

Disadvantages of Price Discrimination

• Higher prices : As indicated above, some consumers will face lower prices while others will face higher prices. Consumers that face higher prices (i.e., consumers who purchase airline tickets during peak season) are disadvantaged.
• Reduction in consumer surplus : The pricing strategy reduces consumer surplus and transfers money from consumers to producers, leading to inequality.

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Price Discrimination (Empirical Studies)

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• Frank Verboven  

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Price discrimination occurs when the prices of similar products sold by the same firm show variation that cannot be attributed to variation in marginal costs. Direct (or third-degree) price discrimination serves to exploit observed differences in consumer characteristics; indirect (or second-degree) price discrimination exploits unobservable consumer heterogeneity. While price discrimination has been studied extensively by economic theorists, and illustrated with numerous textbook examples (for example, price discrimination (empirical studies) 623 Scherer and Ross, 1990), it has only recently become an area of rigorous empirical research. Empirical studies have focused on several questions: ( a ) the measurement or identification of price discrimination; ( b ) the sources of price discrimination, notably the role of competition; and ( c ) the effects of price discrimination on profits, consumer welfare and efficiency.

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© 2008 Palgrave Macmillan, a division of Macmillan Publishers Limited

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Verboven, F. (2008). Price Discrimination (Empirical Studies). In: Durlauf, S.N., Blume, L.E. (eds) The New Palgrave Dictionary of Economics. Palgrave Macmillan, London. https://doi.org/10.1007/978-1-349-58802-2_1333

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Behind Uber’s new pricing model: How price discrimination works

By  Jordi McKenzie , Macquarie University

Price discrimination is a firm’s attempt to capture the difference between the value a consumer puts on a product and how much they actually pay. Firms do this by charging different prices to different consumers and exploiting differences in willingness to pay.

While this sounds like it comes at the expense of consumers, economic theory shows that society as a whole can benefit if certain conditions are met. For example, if Uber’s new pricing means it can enter new markets or reduce customer waiting times, price discrimination could increase society’s overall welfare.

Price discrimination takes many forms, such as Coca-Cola’s infamous vending machines that increase soft drink prices as the outside temperature increases , or charging more for pink razors .

Cheap movie tickets on Tuesdays are another example of price discrimination, as are the different priced tickets at the theatre and concerts . Pharmaceutical companies charge different prices in different countries , and car dealers negotiate and give out discounts .

The airline industry is often regarded as the champion of price discrimination. It price discriminates on almost every aspect of a fare — from the time a booking is made to the type of seat booked, and, of course, the actual route flown.

The only surprise is that Uber hasn’t implemented such a system before now. Its success has, in large part, been driven by a business model that so cleverly mimics a free-functioning market, notably with its “ surge pricing ”.

What is price discrimination?

Price discrimination is the practice of charging different “types” of consumers different prices for the same product or service.

Broadly, “type” might be based on an observable characteristic (age, gender or residency status for example) or some unobservable characteristic that is revealed through the consumer’s actions or preferences (coupon discounts, early bird specials, happy hour deals and so on).

Regardless of the mechanism, the objective is to exploit the different “willingness to pay” (WTP) between consumers and thereby increase profits. WTP describes the maximum amount a consumer would pay for a particular product or service. Given consumers differ in incomes and other circumstances, this presents an opportunity that firms may exploit through price discrimination.

Economists generally refer to three types of price discrimination: first degree, second degree, and third degree.

First degree generates the most profit. It involves each consumer paying the maximum price they are willing to pay and the firm extracting all of their WTP.

With the exception of some internet auctions , pure first degree price discrimination isn’t very common. But we can see versions of it where consumers pay a fixed fee in addition to ongoing fees (such as residential water pricing), and where a single price covers both access and (limited) consumption (such as internet services with data limits). If properly designed, these alternative pricing systems mimic first degree price discrimination by capturing the maximum profit available.

Second degree price discrimination involves providing discounts for bulk purchases. While generally not achieving the same level of profits as first degree, the profits from second degree price discrimination still dominate over simple uniform pricing (where one price is charged to all consumers).

This type of pricing doesn’t require a consumer to necessarily be identified by an observable characteristic, rather they reveal their “type” through their purchases. For example, a consumer who buys a 24-pack of soft drink cans at the supermarket generally receives a discount (per can) over the shopper who buys a single can.

Third degree price discrimination involves selling the same good or service to different segments of a market, based on willingness to pay. This is implemented using some identifiable consumer attribute, such as geography or age. An example would be train operators charging different prices to adults and students.

Price discrimination based on geography

It is this third type of price discrimination that Uber is adopting. Although some customers will object to paying different amounts for the same distance travelled, Uber is certainly not the first company to exploit a geographic dimension when it comes to pricing decisions.

Many other businesses similarly base pricing decisions on location and (implicitly) the WTP of consumers in the markets they serve. For example, cafes, restaurants and bars operating in popular tourist destinations often charge substantially more than similar venues in neighbourhood locations. Although this may, to some extent, reflect higher costs, that typically doesn’t explain the entire difference.

The subtle point is what economists refer to as “ net prices ”, which occur only when price differences for different versions of the same good are not reflected in different costs.

So is Uber’s plan to charge prices according to the customers’ locations something that should cause users to take to the streets in mass protest, or at the very least raise concerns of regulators? Probably not. After all, it isn’t as if Uber is itself a monopoly. There are always taxis as an alternative. But, of course, the taxi industry has always been partial to a little price discrimination itself. It just isn’t as good at it.

Jordi McKenzie  is a senior lecturer in the Department of Economics at  Macquarie University . 

This article was originally published on The Conversation . Read the original article .

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Improving economics teaching and learning for over 20 years

Case 6: Price discrimination (homework)

In essence students are given here the repeated opportunity to select the best price schedule when various forms of price discrimination are possible. The student is the seller who can sell up to two identical items to each of two different buyers. Each item costs £5 to produce. The computer takes the role of the two buyers who have the following valuations for the item:

As illustrated in the table, the second item adds no value for buyer A, but a value of 10 for buyer B. Twenty rounds are played. In the first five rounds the same, uniform price has to be set for each unit sold to any buyer (uniform price, no price discrimination). In the next five rounds different prices may be charged to different buyers, but the same price must be taken for each unit (third-degree price discrimination). In rounds 11–15 the prices have to be the same for both buyers, but different prices can be charged for different units (second-degree price discrimination). Finally, in the last five rounds different prices can be taken per unit and per consumer (first-degree price discrimination).

It is best to let students do the experiment before price discrimination is discussed in the lecture. One can then discuss each scenario in a classification of price discrimination. The lecturer can ask the students how much money it was possible to make in each scenario and why. It will become transparent why the detailed form of price discrimination matters.

In analysing results in second year microeconomics, 90 students participated in our experiment. Only two managed not to get the right answer ever in the first five rounds. The next five rounds are more difficult and about 25% have difficulties in finding the correct answer. Rounds 11–15 are the hardest and only 50% get it right most of the time (i.e. at least two times out of five). There is only a slight improvement for the last five rounds where about 40% of the students never get a profit above 40 and hence do not see how to get a higher profit out of buyer B by discouraging them to buy a second unit. Admittedly, we did not give incentives for good performance and so we see that there is a substantial fraction of non-serious answers (about 20%). Still, it is revealing to see where some of the students have serious difficulties to which one can respond in a class discussion

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