Third degree price discrimination is also called direct price competition. The alternative, indirect price competition, is when a company simultaneously sets different prices according to different classes of customers (e.g., age), but directly targets one group with a lower cost, e.g., bulk purchasing gets much lower average rate. Companies can make money either way - if they offer the best price to each class of customer, they will get more business and make more profit, or if they offer prices that are too low, they will lose money and be unable to stay in business.
A third degree price discrimination strategy uses discounts to entice customers to buy more. Discounts are an excellent way to attract new customers, especially when those customers have little money to spend. But these discounts should not be given freely. Instead, some should be given to a select group of customers with an ability to pay higher costs for their purchases. For example, a discount may be given to a consumer with a history of a healthy diet and regular workouts.
The other form of price discrimination involves a company's use of market-specific or institutional pricing practices. Third degree price discrimination on the institutional level refers to the practice of charging different prices to different classes of customers based on factors such as the size of the company, the number of outlets, or the variety of products offered. Price discrimination on the market-specific level refers to differences in prices charged by companies to similar products in the same category. This type of discrimination can lead to severe price competition among small businesses. For example, a department store could charge different prices for the same item.
The third degree price discrimination occurs when a company offers its products and services to consumers at different rates. For instance, a hotel could offer hotel packages to individuals at a lower rate than to couples. A manufacturer could offer its products and services to consumers at a lower price than to consumers who order items from its own web site. These practices often result in inelastic demand because the higher prices displace the inelastic demand caused by the lower prices.
Third degree price discrimination in the business market has long been described as a phenomenon where a firm charges one price (the marginal cost) for the same product while allowing other firms to charge higher prices for the same goods and services. The concept of marginal cost is related to the concept of demand structure. In simple terms, a firm determines its marginal cost of production according to the amount it would need to generate the surplus, or value, to cover the expenses for all its inputs if the sale of the product goes through. The value of a firm's inputs will depreciate as a proportion of its total sales and will increase as the firm's profits increase. This means that firms will tend to charge higher prices for marginal goods and services than they would if the same tasks were performed using a different set of inputs.
The practice of differential pricing allows firms to discriminate against certain categories of consumers and is a classic example of a practice motivated by both profit and power. Power simply means that firms with sufficient amounts of power can command the decisions of all consumers within the market, subjecting those consumers to whatever practices they choose to implement. Profit, on the other hand, is typically defined as the reward provided to the firm for devising a profitable venture. By charging different prices to different classes of consumers, a firm can ensure that its firm has more money generated than its competitors, or that it receives enough profit to allow it to reward the socially profitable practices that it chooses to adopt.
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