Conditions and three types
A firm needs market power to set prices, a way to separate customers with different willingness to pay, and a way to prevent resale. Pigou identified three types. First-degree (perfect) discrimination charges each buyer their maximum, as in auctions or custom quotes. Second-degree varies price by quantity or version so customers self-select—bulk discounts, economy vs. business class, free vs. paid tiers. Third-degree charges groups differently—student, senior, or matinee pricing.
Effects and controversy
Price discrimination shifts consumer surplus to firms, but it can also expand output by letting price-sensitive buyers in at lower prices. Dynamic pricing—airline fares, rideshare surge pricing—and data-driven personalized pricing raise fairness concerns. It changes contribution margins and thus the break-even point, and tiered freemium and subscription plans are classic second-degree examples. In the U.S., the Robinson-Patman Act restricts some business-to-business price discrimination.
FAQ
- Is price discrimination illegal?
- Mostly legal, but pricing based on protected characteristics or that harms competition can be restricted.
- Are coupons price discrimination?
- Yes—they target price-sensitive shoppers willing to make the effort.
Sources reviewed: 2026-10-26
References
- Pigou, A. C. (1920). The Economics of Welfare. Macmillan.
- Varian, H. R. (2014). Intermediate Microeconomics (9th ed.). W. W. Norton.
- Shapiro, C., & Varian, H. R. (1998). Information Rules. Harvard Business School Press.