The Competitive Effects of Price Discrimination

The competitive effects of price discrimination depend on the situation in question. Sometimes price discrimination will result in more competition and sometimes in less. But if price discrimination enables a firm to discover that the demand for its product is more elastic than was previously thought, price discrimination will have beneficial effects for consumers.

Firms that operate on the elastic portion of the demand curve will generate higher total revenues by lowering their prices. If price discrimination leads a firm to discover that demand for its product is more elastic than the firm previously expected, then the firm will drop the price it charges permanently as a result of having engaged in price discrimination. Consumers are benefited as a result of this discovery, and more price competition exists in its aftermath.

Note: A profit-maximizing firm will never price in the inelastic portion of its demand curve. By raising prices in the inelastic portion of the demand curve, the firm can increase its total revenue, decrease its total cost, and unambiguously increase its profit. Thus, the firm will increase its price until it is in the elastic portion of the demand curve, where there exists a tradeoff in which a firm, by decreasing its price, will raise its total revenues but also raise its total costs. In the elastic region of the demand curve, the firm will engage in trial and error to find which is the right price to charge.

There exist other positive competitive effects to price discrimination. Haggling - an attempt to get at first-degree price discrimination - leads to greater overall sales and lower prices for some. Haggling also forces dealers to be more aggressive in their pricing.

For instance, providers of phone plans engage in tremendous price discrimination. In past decades, telephone companies would even send individual customers large checks to persuade them to switch to their long-distance providers. Almost no two people pay the same rates for their telephone plans, but many are able to get telephone service while paying less than they would have paid if a single uniform price existed.