Price elasticity is one of the three necessary requirements for price discrimination to be possible. If difference in price elasticity does not exist for different customer segment, a firm cannot engage in price discrimination.
Differing levels of price elasticity allows a company to offer different prices for the same product to different customers, knowing fully well that the demand for price inelastic customers would not decline much while the demand through price elastic customers would increase by a much higher margin.
The first example illustrates the large increase in profits of an airline which has 50% each, price inelastic and price elastic customers and practices price discrimination. The second example shows that for the same airline, if a higher number of customers are price elastic, the increase in profit is lesser as compared to the first case. The third example again shows that the effect of price discrimination through increase in profits for a movie theatre.
The three examples highlight the importance of identifying the customer segments and offering different prices to those segments in a manner which would result in higher profits while at the same time ensuring that the overall demand levels do not decline.
Price discrimination allows price elastic customers to pay lesser for the same services while also allowing firms to maximise their revenue, especially during non-peak season. Further, during peak season, the practice allows firms to deliberately decongest demand, which works well in case of public services (KellyandJenny, 2012).
The main disadvantages faced from price discrimination is by customers who have to pay higher. While a firm can also be in a disadvantageous position if the proportion of price elastic customers is very high in the overall demand, which would diminish the potential gains from price discrimination (Pettinger, 2008).
References
Pettinger, T. (2008). Benefits of Price Discrimination. Economics Help. Retrieved from http://www.economicshelp.org/blog/306/concepts/benefits-of-price-discrimination/.
KellyandJenny. (2012). Price Discrimination: Advantages and Disadvantages. KellyandJenny. Retrieved from https://kellyandjenny.wordpress.com/2012/01/17/price-discimination-advantages-and-disadvantages/.
