In simple terms
A friendly intro before the formal notes — no formulas yet.
Same Product, Different Prices
Price discrimination is when one seller charges different prices to different buyers for an identical product, and the price gap is not explained by any difference in cost. The seller is simply pricing according to what each buyer will pay.
Two people board the same flight, in the same economy cabin, on the same plane. One booked three months early and paid $90; the other booked the day before a business meeting and paid $340. The seat, the fuel and the crew cost the airline the same either way. The price gap exists because the last-minute traveller has few alternatives and an urgent need — their demand is far less elastic — so the airline can charge them much more.
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The firm needs market power — a price taker in perfect competition cannot do this at all.
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The firm must be able to separate buyers into groups that differ in how price-sensitive they are (different PED).
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The firm must be able to stop resale, so cheap buyers cannot undercut it by reselling to expensive buyers.
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It then charges a higher price to the group with more inelastic demand and a lower price to the group with more elastic demand.
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Full topic notes
Formal explanation with the rigour you need for the exam.
What price discrimination is — and is not
Price discrimination means charging different prices to different consumers for the same product, where the price difference is not based on differences in cost. That final clause is the whole point. If an online retailer charges a customer in a remote area more because delivery genuinely costs more, that is a cost difference, not discrimination. Price discrimination only exists when the cost of supplying each buyer is (roughly) the same, yet the prices differ — because the buyers differ in their willingness to pay.
Same product — the good or service supplied to each buyer is essentially identical.
Different prices — buyers are charged different amounts.
Not cost-based — the price gap is explained by differences in demand (willingness to pay / PED), not by differences in the cost of supply.
The three necessary conditions
A firm cannot simply decide to price discriminate. Three conditions must all hold at once; remove any one and the strategy collapses. Learn them as a checklist, because Paper 3 'explain the conditions' questions award a mark for each condition correctly identified and explained.
1. Market power. The firm must be a price maker with the ability to set its own price, so it must operate in a monopoly, oligopoly or monopolistically competitive market. A perfectly competitive firm is a price taker facing a single market price and simply cannot charge different buyers differently.
2. Ability to separate consumers by PED. The firm must be able to sort buyers into groups whose price elasticities of demand differ, using an observable signal such as age, student or senior status, time of purchase, or geographic location. Without different PEDs there is no gain from charging different prices.
3. Ability to prevent resale (no arbitrage). The firm must stop buyers who pay the low price from reselling to those who would pay the high price. If resale is easy, the low price leaks into the high-price segment and the two prices converge. This is why services (a haircut, a cinema seat, a doctor's appointment) are far easier to discriminate on than storable physical goods.
In a Paper 3 'explain the conditions' question, do not just list the three words. For each condition, add the reason it matters — e.g. 'market power, BECAUSE a price taker cannot set its own price.' Our marking engine awards a separate point for each condition that is both identified and briefly justified.
The three degrees of price discrimination
Economists classify price discrimination by how finely the firm can distinguish and charge buyers, from the near-impossible ideal (first degree) to the everyday reality (third degree).
First-degree (perfect) price discrimination. The firm charges each buyer the maximum they are willing to pay for each unit, extracting all consumer surplus and turning it into producer surplus. It is largely theoretical because it requires perfect knowledge of every buyer's willingness to pay; the closest real examples are individually haggled prices, bespoke professional quotes, or some auctions.
Second-degree price discrimination. The firm charges different prices for different quantities or 'blocks' bought by the same consumer — bulk discounts, 'buy more, pay less per unit', or a utility bill where a first block of units is priced differently from later units. Here the buyer effectively self-selects the price by choosing how much to buy.
Third-degree price discrimination. The most common form. The firm divides consumers into distinct, identifiable groups and charges each group a different price — the same price for everyone within a group, a different price between groups. Examples: adult vs. student cinema tickets, peak vs. off-peak rail fares, and academic vs. commercial software licences. This is the form you must be able to draw.
The effect on the firm and on consumers
Price discrimination redistributes surplus. Evaluating who gains and who loses — and being precise about consumer surplus — is exactly what higher marks reward.
The firm gains. Total revenue and profit rise relative to a single price, because the firm captures consumer surplus it would otherwise have left with buyers. Every buyer who was willing to pay more than the single price is now charged closer to their maximum.
Inelastic-group consumers lose. They face a higher price and their consumer surplus shrinks.
Some elastic-group consumers gain. They pay a lower price, and crucially some who would have been priced out entirely under a single monopoly price can now afford the product and are served.
Overall consumer surplus usually falls, transferred to the firm as extra profit; under first-degree discrimination consumer surplus falls to zero.
Efficiency is ambiguous. Output can rise because extra buyers are served, moving output nearer the competitive level — and a firm that would have made a loss at a single price might survive and supply the market at all. But the price still exceeds marginal cost for most buyers, so allocative inefficiency is reduced, not removed.
Diagram: third-degree price discrimination with two markets
The standard HL diagram places two sub-markets side by side. Both are supplied by the same firm at the same marginal cost, but each has its own demand and marginal revenue curves reflecting its own elasticity. The firm maximises profit by setting MR = MC separately in each market.
Model answer — marked against the real Paper 3 marking engine
Paper 3 is marked on a POINTS basis: each distinct valid point or step earns a mark. For a quantitative part, a mark is available for the correct METHOD (M) and a mark for the correct ANSWER with accuracy (A), working must be shown, and follow-through applies — a correct method built on an earlier slip can still earn the method mark. The worked example below shows exactly how the marks are allocated.
Common mistakes examiners penalise
Saying discrimination is driven by different COSTS. It is driven by different price elasticities of demand. A cost-based price gap is not price discrimination at all.
Claiming a perfectly competitive firm can price discriminate. It cannot — it is a price taker with no market power; condition 1 fails.
Forgetting the resale condition. Many answers give only market power and different PED and stop. Preventing arbitrage is a full third condition and a full third mark.
Charging the higher price to the ELASTIC group. It is the INELASTIC group (less responsive to price) that pays more; reversing this loses marks.
Reading price off the MR curve on the diagram. Find quantity where MR = MC, then go up to the DEMAND curve for the price.
Not showing working in the calculation. Paper 3 awards a method mark (M1) separately from the accuracy mark (A1); an answer with no working forfeits the method mark and blocks follow-through.
Asserting consumers always lose. Overall consumer surplus usually falls, but some elastic-group buyers gain a lower price and some are served who would otherwise be priced out — a nuanced answer scores higher.
Where this leads
Price discrimination is a direct application of two ideas you already know: market power (from the theory of the firm) and price elasticity of demand (from Unit 2). Recognising that a firm's pricing depends on how elastic each buyer group is will resurface whenever you analyse monopoly, revenue maximisation, or the welfare effects of market power — and, on Paper 3, wherever a question asks you to calculate revenue across segmented markets.
Worked examples
See the formulas applied — reveal one step at a time, like the exam.
Using a diagram, explain how a firm practising third-degree price discrimination sets its price and quantity in two markets, A and B, where demand in market A is more inelastic than in market B, and marginal cost is constant and the same for both.
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The firm is a price maker (market power) and can separate the two markets and prevent resale, so it can treat A and B independently.
Paper 3: Explain the conditions necessary for a firm to practise price discrimination, and calculate the total revenue if it sells 200 units at $8 in market A and 150 units at $12 in market B. [5]
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Market power — the firm must be a price maker (e.g. a monopoly or other imperfectly competitive firm), because a perfectly competitive price taker cannot set different prices.
How it all connects
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Glossary
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Quick check
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Revision flashcards
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Price discrimination
Charging different prices to different consumers for the same product, where the price difference is NOT based on any difference in cost of supply.
Key takeaways
Review these before you close the topic — retrieval beats re-reading.
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Same product — the good or service supplied to each buyer is essentially identical.
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Different prices — buyers are charged different amounts.
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Not cost-based — the price gap is explained by differences in demand (willingness to pay / PED), not by differences in the cost of supply.
Practice — then mark it
The whole point: a real Cambridge question, marked mark-by-mark.
Get a Paper 3 answer marked: explain the conditions for price discrimination and calculate total revenue across two markets
Get a Paper 3 answer marked: explain the conditions for price discrimination and calculate total revenue across two markets
Extra simulations & links
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Frequently asked
Checkpoint
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