All subjects · Economics · WEC13 Business behaviour

Third-degree price discrimination

Edexcel IAL Economics · WEC13 Business behaviour

Price discrimination means charging different prices to different groups of consumers for the same product, where the price differences are not due to cost differences.

Practise this in the app: instant marking and a fix for every mistake. Free, no email needed to start.

Practise this lesson

Conditions

1. The firm must have price-setting (market) power.

2. It must be able to separate the market into groups (by age, time, location) and stop resale (arbitrage) between them.

3. The groups must have different price elasticities of demand.

How it works

Third-degree price discrimination charges a different price in each sub-market. The firm sets MC = MR in each market: the higher price goes to the market with the more price inelastic demand, and the lower price to the more elastic market.

Examples: peak and off-peak rail fares, student and senior discounts, cinema tickets by time of day, prices that differ by country.

Diagram in words: three panels. Left: inelastic market, steep AR and MR. Middle: elastic market, flatter AR and MR. Right: combined MR, with one MC line. Draw a horizontal line from where MC meets combined MR across to each market's MR; read each market's output and its price from its own AR.

Effects

Producers: higher total revenue and profit than a single price; converts consumer surplus into producer surplus.
Consumers: those in the inelastic market pay more and lose consumer surplus; those in the elastic market may pay less, and some who could not afford the single price now buy.
Output and efficiency: output may rise, so some allocative gain; profits may fund investment or cross-subsidise services (for example, off-peak services that would otherwise close).
Equity: some see it as unfair; others as fair if lower-income groups get the lower price.

Worked example

A rail firm has MC = $10 per trip. Peak demand: P = 50 - Q (MR = 50 - 2Q). Off-peak demand: P = 20 - 0.5Q (MR = 20 - Q). Find the price in each market.

Peak: 50 - 2Q = 10, so Q = 20; P = 50 - 20 = $30.
Off-peak: 20 - Q = 10, so Q = 10; P = 20 - 0.5 x 10 = $15.
The peak market is more price inelastic at these prices, so it pays more.

Answer: Peak $30; off-peak $15.

Key idea: Conditions: market power, separable markets with no resale, different PEDs. Set MC = MR in each market; higher price in the more inelastic market. Firms gain profit; some consumers gain, some lose.

Check yourself

Using the rail example (MC = $10), find total profit from the two markets if there are no fixed costs.
Show answer
$450. Peak: (30 - 10) x 20 = 400; off-peak: (15 - 10) x 10 = 50; total $450.
A theme park has MC = $6. Adults: MR = 90 - 2Q. Children: MR = 30 - Q (Q in hundreds). Find the number of adult tickets sold, in hundreds.
Show answer
42 hundred. 90 - 2Q = 6, so Q = 42 hundred.
Which is a necessary condition for third-degree price discrimination?
- The firm is a price taker
- Consumers can easily resell the product
- Costs differ between markets
- Consumers in different markets have different price elasticities of demand
Show answer
Consumers in different markets have different price elasticities of demand. Without different PEDs there is no gain from different prices.
Under price discrimination, the higher price is charged in the market where demand is
- more price inelastic
- more price elastic
- perfectly elastic
- falling
Show answer
more price inelastic. Consumers there respond less to a higher price.
Why must resale between markets be prevented?
- Resale raises the firm's costs
- Resale is always illegal
- Otherwise buyers in the cheap market would resell to the expensive market
- It makes demand perfectly inelastic
Show answer
Otherwise buyers in the cheap market would resell to the expensive market. Arbitrage would push the two prices together.
Which is an example of third-degree price discrimination?
- Cheaper train tickets for off-peak travel
- A higher price for first-class seats with more space
- A discount for buying in bulk because delivery costs are lower
- Charging more for a larger pizza
Show answer
Cheaper train tickets for off-peak travel. The same journey at a different price by time, not because of cost.
What happens to consumer surplus in the inelastic market when price discrimination is introduced?
- It rises
- It is unaffected
- It falls, as some is converted into producer surplus
- It becomes negative
Show answer
It falls, as some is converted into producer surplus. Those consumers pay a higher price than under a single price.

Practise with instant feedback

Sources

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (XEC11/YEC11), Unit 3 Business behaviour and Appendices 6 and 7

Last updated 8 November 2026. Spotted a mistake? Tell us.