Introduction

People value the same products differently. Therefore, they will pay more or less for the same products. How, then, as a seller of products, do you make the most money? You try to charge people as close to the best price you can get from them.

Simplified example

Let's say you sell Lorems. Lorems cost $2 each to make, and only three people care about buying Lorems: Alpha, Beta, and Omega. Alpha will pay up to $10; Beta will pay up to $5, and Omega will pay up to $1.

If you sold Lorems at $5 each, you would make 2 * ($5 - $2) = $6. Nice, 6 is a perfect number.

However, suppose you know Alpha refuses to cut coupons; Alpha thinks cutting coupons wastes their time, and working as an Ipsum Consultant, Alpha cannot afford to waste time. You also know Beta loves to cut coupons; as a star on an extreme couponing TV show, they make their name from getting the most out of coupons.

Then if you sold Lorems at originally $10 each, $5 each with coupon, you would make $10 + $5 - $2 - $2 = $11. Even better!

Hurdles

Price discrimination involves charging different prices for the same product. From the seller's perspective, price discrimination ideally adjusts price as close to the maximum prices buyers would pay, known as their “willingness to pay,” without going over. To do this, sellers often implement a hurdle between a higher and lower price.

In the simplified example, the coupon formed the hurdle between the higher and lower price. Hurdles, however, come in many forms, effective as long as they correctly distinguish between willingnesses to pay.

Airlines

Airlines will charge different prices for the same seat on the same flight, depending on how long before the flight the customer books the ticket.

Generally, the earlier the customer books, the cheaper the flight. A customer who really wants/needs a cheaper ticket will go through the hurdle of booking earlier; a customer who doesn't care as much will book at a more convenient time. Additionally, a customer with a strict, urgent need to fly will book close to departure, and will pay more for it.

Conclusion

Of course, price discrimination doesn't come so simply or perfectly as the Lorem example in the real world. Sellers will often employ multiple types of hurdles, or not implement some hurdle at all because it costs too much. Obviously, no combination of hurdles will perfectly adjust to people's willingnesses to pay, and people will react negatively if they feel they're getting gouged.

Overall, though, price discrimination lets sellers make much more out of people's differing perceptions of value, and you as a consumer can get a much better price by figuring out how exactly sellers engage in price discrimination.