Price Discrimination

The Web site of computer manufacturer Dell asks prospective buyers to declare whether they are a home user, small business, large business or government entity. Two years ago, the price of a 512MBmemory module, part number A0193405, depended on which business segment one declared. At that time, Dell quoted $289.99 for a large business, $266.21 for a government agency, $275.49 for a home, and $246.49 for a small business. What explains these price differences? How does Dell benefit from it? Different segments have different willingness to pay. Dell optimizes its prices, offering lower prices to relatively price-sensitive segments. An interesting aspect of Dell’s attempt to charge different prices to different customers is that the customers aid Dell in its effort. According to a Dell spokesperson, each segment independently sets prices and the customer is free to buy from whichever is cheapest. Thus, the customers paying more are choosing to pay more, probably because they do not expect the prices to vary so significantly. This chapter explores the economic rationale for price discrimination. Section 2 presents the basic theory of price discrimination and describes the conditions necessary for price discrimination to exist. Section 3 then discusses direct price discrimination, while indirect price discrimination is discussed in Section 4. Section 5 provides a discussion of the welfare effects associated with price discrimination, while Section 6 concludes this chapter with a discussion of the antitrust implications of price discrimination.