The profit-maximizing output-price combination in the absence of price discrimination is Q* and P*. However, if the firm is able to charge prices such that the customer pays the exact amount which is equal to his maximum willingness to pay, the firm would charge a customer Pc if his maximum WTP is Pc at the same time charging another customer Pmax if that is his maximum WTP. Note that here; the advantage of price discrimination is not to the producer only. Due to price discrimination, customers who had WTP<P* were unable to purchase the product. However, now, every customer who has a WTP>MC can consume it.
The case when each of the customers is charged a different price, it is called the first degree of price discrimination or perfect price discrimination. When the price depends on the quantity purchased such that those buying higher amount of a given commodity are charged lesser price, it is called second degree price discrimination. When different prices are charged to different groups of people, it is called third degree price discrimination.
First degree price discrimination is a virtual impossibility. Second degree price discrimination is visible in several cases when there are discounts on certain minimum amount or quantity of purchase for example, an offer that allows a 50% off on every third trouser purchased falls under this category. Third degree price discrimination is perhaps the most evident form of price discrimination. In the case of movie ticket pricing, the third degree of price discrimination is most evident. Availability of movie tickets at different prices for children, adults and elders is one such example. Some other forms of price discrimination that are evident in the case of interest are inter-temporal pricing and peak load pricing. Inter-temporal pricing is the form of price discrimination when prices are charged high initially to exhaust the inelastic market after which the prices are lowered to capture the more elastic market. In movie ticket pricing, when a movie is released, the price of the tickets are quite high. Once that group which watches the movies on a priority basis immediately after its release is covered, the price is lowered so that those with flexible demand are also accommodated. Peak-load pricing is another type of price discrimination in which the tickets are costly during the weekends when the demand for entertainment avenues are high whereas the same is low during weekdays when the demand is low.