Business Economics · Profit maximisation under imperfect competition

Price Discrimination: Types, Conditions and Third Degree Numericals

Updated 11 October 2026 · Fact-checked

Price discrimination means charging different prices for the same product when cost differences do not explain the gap. It raises profit by capturing more consumer surplus. For third degree, split the market, set MR in each equal to common MC, then read each price off its own demand curve.

Understand Price Discrimination

A firm with market power faces a downward-sloping demand curve. If it charges one price to everyone, it loses revenue from buyers who would have paid more, and it turns away buyers who would pay more than cost but less than the price. Price discrimination tries to fix both problems.

The firm needs three conditions. First, it must have some market power, so it is a price maker. Second, it must be able to separate buyers by willingness to pay, using information, age, location, time or quantity. Third, it must prevent resale (arbitrage). If low-price buyers can resell to high-price buyers, the scheme collapses. Different price elasticities across groups are what make it worth doing.

First degree (perfect) discrimination charges each buyer their maximum willingness to pay. The firm sells up to the point where price equals MC. Output is the same as in perfect competition. Consumer surplus falls to zero and the firm takes it all as producer surplus. It is efficient (no deadweight loss) but very unequal. It is a theoretical limit, since the firm would need to know every buyer's value.

Second degree discrimination uses the pricing structure itself. The firm cannot see who is who, so buyers choose. Examples are quantity discounts, block tariffs, and versioning such as economy and business class. Prices vary by quantity or quality, not by person.

Third degree discrimination splits buyers into identifiable groups, such as students and adults, or domestic and export markets, and charges each group one price. The profit-maximising rule is to equate MR in each market to the same MC. The group with less elastic demand pays the higher price. Profit is at least as high as with a single price. Consumer surplus overall usually falls, though some groups may gain.

Key rules to remember

Profit maximisation with one cost curve: MR₁ = MR₂ = MC (total output Q = Q₁ + Q₂); Third degree with two markets. MC is evaluated at total output, not per market.
Marginal revenue and elasticity: MR = P × (1 − 1/|ε|); Here ε is price elasticity of demand. Valid for a point on a demand curve.
Price ratio across markets: P₁ ÷ P₂ = (1 − 1/|ε₂|) ÷ (1 − 1/|ε₁|); Follows from MR₁ = MR₂. The market with the lower |ε| gets the higher price. Needs |ε| > 1 in both.
Linear demand and MR: If P = a − bQ, then MR = a − 2bQ; MR has the same intercept and twice the slope.
First degree outcome: P = willingness to pay for each unit; output where P = MC; consumer surplus = 0; Total surplus equals the perfectly competitive level.
Profit: π = P₁Q₁ + P₂Q₂ − C(Q₁ + Q₂); Compare with the single-price profit to show the gain.

How to solve Price Discrimination questions

Use this method for numerical and written questions on price discrimination.

1Identify the type: individual willingness to pay (first), quantity or quality menu (second), or identifiable groups (third).
2For a written question, state the three conditions: market power, ability to separate buyers, no resale. Link each to the case given.
3For a third degree numerical, write each demand curve in the form P = a − bQ and derive MR for each market.
4Set each MR equal to MC. If MC is constant, solve each market on its own. If MC depends on total output, set MR₁ = MR₂ = MC and solve together.
5Find Q₁ and Q₂, then read P₁ and P₂ from the demand curves. Check that the less elastic market has the higher price.
6Compute revenue, cost and profit. If asked, find the single-price profit by combining the markets and compare.
7Comment on consumer surplus, producer surplus and efficiency, and state any assumptions.

Quickest way: Equalise MR, then price off demand

When to use it: Use for third degree numericals with two linear demand curves and a constant or simple linear MC.

Write MR for each market: intercept a stays, slope doubles.
With constant MC, solve a₁ − 2b₁Q₁ = MC and a₂ − 2b₂Q₂ = MC separately.
Put Q back into each demand curve for the price. Do not put it into MR.
Sanity check: compute |ε| at each optimum. The market with the lower |ε| (with constant MC, the one with the higher demand intercept) should have the higher price.
For the single-price comparison, add the quantities horizontally and use the kinked MR only if the question demands it.

Common mistakes in Price Discrimination

Setting MR in each market equal to the price of the other market, or setting prices equal.
Students remember that equal marginal revenues is the rule but mix it up with equal prices.
Fix: Equalise MR across markets and to MC. Prices will differ.
Substituting Q into the MR function to get the price.
MR is the function being solved, so it feels natural to reuse it.
Fix: MR is used only to find Q. Always read price from the demand curve.
Evaluating MC at each market's output when MC depends on total output.
Students treat the markets as separate firms.
Fix: Use MC at Q = Q₁ + Q₂. Solve MR₁ = MR₂ and MR₁ = MC together.
Saying price discrimination is possible without market power, or listing only 'different prices' as the condition.
The definition is learned without the conditions.
Fix: Always give all three conditions: market power, separation of buyers, prevention of resale.
Claiming all consumers lose or that output always rises.
Overgeneralising from first degree.
Fix: Say consumer surplus in total generally falls but some groups may gain. Output can rise or fall in third degree. In first degree it rises to the competitive level.
Confusing second and third degree.
Both involve discounts.
Fix: Second degree: the buyer selects from a menu. Third degree: the seller assigns groups using an observable trait.

Worked examples

Example 1

A monopolist sells in two separate markets with constant MC of ₹20. Demand in Market A is P = 100 − 2Q. Demand in Market B is P = 60 − Q. Find the profit-maximising price and quantity in each market and total profit.

Show the solution

Market A: MR = 100 − 4Q. Set 100 − 4Q = 20, so Q = 20.
Price in A: P = 100 − 2(20) = ₹60.
Market B: MR = 60 − 2Q. Set 60 − 2Q = 20, so Q = 20.
Price in B: P = 60 − 20 = ₹40.
Revenue: A = 60 × 20 = ₹1,200. B = 40 × 20 = ₹800. Total = ₹2,000.
Cost = 20 × 40 = ₹800 (no fixed cost given).
Profit = 2,000 − 800 = ₹1,200.
Check: A has the higher price, so A is the less elastic market. At P = 60 in A, ε = (1/2)(60/20) = 1.5 in absolute terms. At P = 40 in B, ε = 40/20 = 2. Correct.

Answer: Market A: Q = 20, P = ₹60. Market B: Q = 20, P = ₹40. Total profit = ₹1,200.

Example 2

Using the same data as the previous example, find the single-price profit if the monopolist cannot discriminate and must charge one price in both markets. Both markets are served. Compare with the discriminating profit.

Show the solution

Invert each demand curve: A: Q = 50 − 0.5P. B: Q = 60 − P. Both are valid for P ≤ 60 (B's maximum price is 60, A's is 100).
For P ≤ 60, total demand Q = 110 − 1.5P, so P = (110 − Q) ÷ 1.5 = 73.33 − 0.6667Q.
MR = 73.33 − 1.3333Q. Set equal to 20: 1.3333Q = 53.33, so Q = 40.
Price: P = (110 − 40) ÷ 1.5 = 70 ÷ 1.5 = ₹46.67. This is below 60, so the formula for both markets is valid.
Revenue = 46.67 × 40 = ₹1,866.67.
Cost = 20 × 40 = ₹800.
Profit = 1,866.67 − 800 = ₹1,066.67.
Comparison: 1,200 − 1,066.67 = ₹133.33 more under discrimination.

Answer: Single price ≈ ₹46.67, Q = 40, profit ≈ ₹1,066.67. Third degree discrimination adds about ₹133.33 of profit.

Exam tips

Write the three conditions in every theory answer and tie each to the scenario given. Marks are usually split across them.
In numericals, show MR for each market, the equation MR = MC, then Q, then P from demand. Examiners award method marks for each stage.
For MCQs, recall that the market with less elastic demand gets the higher price, and that first degree discrimination gives zero consumer surplus and no deadweight loss.
When asked about welfare, give both effects: profit rises, consumer surplus generally falls, and efficiency depends on the type and on output changes.
Label examples correctly. Student discounts and peak or off-peak pricing by group are third degree. Bulk discounts and tiered tariffs are second degree.

Practice questions from Profit maximisation under imperfect competition

Price Discrimination in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Price Discrimination: frequently asked questions

What are the three types of price discrimination?

First degree charges each buyer their maximum willingness to pay. Second degree uses quantity or quality menus that buyers choose from. Third degree charges different prices to identifiable groups, such as students and adults.

What conditions are needed for price discrimination?

The firm needs market power, a way to separate buyers by willingness to pay or elasticity, and a way to stop resale between groups. Without all three, the scheme fails or profit gains disappear.

How does price discrimination increase profit?

It lets the firm charge more to buyers who value the product highly and still sell to buyers who value it less. This captures consumer surplus and can add sales that a single price would lose.

In third degree discrimination, which group pays more?

The group with less elastic demand at the optimum pays the higher price. This follows from setting MR equal across markets, since MR = P(1 − 1/|ε|).