A student and a commuter order the same latte. Should they pay the same price? Your decision form has a setting that says they don't have to.
Learning objectives. After this week you can (1) state the three conditions for price discrimination; (2) explain why the more price-sensitive group gets the lower price; and (3) compute what a discount gives back.
Remember this: the customers most likely to walk get the deal. Everyone else pays full price.
1) Three conditions
Price discrimination is charging different buyers different prices for the same good, for reasons unrelated to cost. It needs market power (a downward-sloping demand curve; a price taker has no price to vary), segments with different elasticities that you can tell apart cheaply (a student ID), and no resale. A hot latte can't be resold, which makes it ideal.
2) Three degrees
- First degree: each buyer pays their exact willingness to pay. A textbook benchmark.
- Second degree: price varies with how much you buy and buyers sort themselves: bundles, size tiers, quantity discounts, the loyalty card.
- Third degree: different prices for groups you can identify: your student discount (0 to 25% on your form), senior prices, or happy hours that discount the quiet hours when baristas and machines would otherwise sit idle.
3) Who gets the lower price
Charge the MORE elastic segment the LOWER price
Students compare prices hardest, so they are your most elastic segment; regulars have the habit and notice price least. A student discount lowers the price only for the group most likely to cross the street, while everyone else still pays full price. It can even be efficient: a student who would skip a $5.00 latte but buys at $4.00 is a sale, and a happy customer, that one price for all would have lost.
4) What the discount gives back
Drink revenue kept = full-price drink revenue × (1 − f × d) (f = students' share of drinks, d = discount)
Half your drinks go to students at 20% off: you keep 1 − 0.5 × 0.20 = 0.90 of full-price drink revenue. On $1,200 that is $1,080, so $120 went back. Each extra student latte at $4.00 with a $1.20 MC adds $2.80, so the discount pays only if it brings about 120 ÷ 2.80 ≈ 43 extra student cups.
Your report doesn't print the student share, but it shows what went back: multiply lattes, drips and pastries by their prices, add them up, and subtract Revenue. If your loyalty card is on, its free drinks are in that gap too. The counts are rounded, so expect a few dollars of noise.
Quick self-check
(a) Your latte is $5.00 with a 20% student discount. What does a student pay? (b) Students buy 40% of your drinks at 25% off. What share of full-price drink revenue do you keep? (Answers: $4.00; 1 − 0.40 × 0.25 = 0.90.)
Common mistakes
- Discounting the customers least likely to leave. That gives margin away for nothing.
- Reading the discount as pure loss. Compare it with the sales you'd lose without it.
- Changing the discount and a price on the same day. You can't tell which one worked.
This week in the arena
Pick one Daily Report. Multiply lattes, drips and pastries by your prices that day and add them up: that is your full-price revenue. Subtract the Revenue on the report. The gap is what your student discount (and loyalty card, if it is on) gave back. Do the extra customers look like they covered it?