Price discrimination—selling the same good to different customers at different prices—is a common feature of many markets. The most obvious form of price discrimination is when a firm sets different prices in different markets—as, for example, when GSK sells Combivir for a high price in Europe and a low price in Africa. Firms also price goods based on characteristics that are correlated with willingness to pay so student and senior discounts are a form of price discrimination, as are the different prices that airlines set for the same flight depending on how far in advance the flight is booked.

Price discrimination isn’t always easy. To price-discriminate, the firm must prevent consumers who are charged a low price from reselling to consumers who would be charged a high price, that is, prevent arbitrage. Price discrimination also requires that the firm know a lot about its customers. The more the firm knows, the better it can price-discriminate. If the firm knew exactly how much each of its customers valued its product and it could prevent arbitrage, the firm could charge each customer that customer’s maximum willingness to pay—this is called perfect price discrimination. Universities come closest to practicing perfect price discrimination because to provide scholarships, the university can demand a lot of information about the income of its students and their families and it’s hard to resell an education.

Tying and bundling are less obvious forms of price discrimination. By setting a low price for printers and a high price for ink, HP is setting different prices for the “ability to print color photos”—a low price for those who print only occasionally and a high price for those who print often. Cell phones are priced below cost and cell phone calls are priced above cost for the same reason.

Bundling goods in a package can also be a form of price discrimination. When consumers place very different values on package components but similar values on the package, bundling can increase profits.

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Firms want to price-discriminate because price discrimination increases profits. Price discrimination may also increase total surplus. Price discrimination is most likely to increase total surplus when it increases output and when there are large fixed costs of development. Price discrimination for pharmaceuticals, for example, lowers the price for consumers in poor countries (thus, increasing output) and, by increasing profits, price discrimination increases the incentive to research and develop new drugs.