How does second-degree price discrimination work?

Second-degree price discrimination, also known as nonlinear pricing, is a strategy used by firms to charge different prices to different groups of consumers based on their willingness to pay. Unlike first-degree price discrimination, where each consumer is charged a personalized price, second-degree price discrimination involves offering different pricing options or quantity discounts to encourage consumers to self-select into different price tiers.

The key principle behind second-degree price discrimination is to capture consumer surplus by extracting more revenue from consumers with a higher willingness to pay, while still attracting price-sensitive consumers. This strategy allows firms to maximize their profits by segmenting the market and charging different prices to different groups of consumers.

One common example of second-degree price discrimination is the use of quantity discounts. Firms offer lower prices per unit for larger quantities purchased. This encourages consumers with a higher demand or willingness to pay to buy more, while still attracting price-sensitive consumers who may only purchase smaller quantities at a higher per-unit price.

Another example is the use of tiered pricing or pricing bundles. Firms offer different packages or tiers of products or services at different price points. Each tier includes a different combination of features, quality, or quantity, allowing consumers to choose the option that best matches their preferences and budget. This way, consumers with a higher willingness to pay can opt for higher-priced tiers with more features, while price-sensitive consumers can choose lower-priced tiers with fewer features.

Overall, second-degree price discrimination works by offering different pricing options or quantity discounts to encourage self-selection of consumers into different price tiers based on their willingness to pay. This strategy allows firms to capture more consumer surplus and maximize their profits by effectively segmenting the market.