Explain, using a diagram, how a firm might use third degree price discrimination to increase their profits.

Third degree price discrimination involves segmenting the market into groups, each with a different willingness to pay. For example, students (who have a lower willingness to pay), and non-students (who earn a wage and therefore have a higher willingness to pay). The answer involves drawing three diagrams, with price on the y-axis and quantity on the x-axis. One group (non-students) would have steeper, more inelastic demand and MR curves, whereas the other (students) would have flatter (more elastic) curves. With these drawn separately on the first two diagrams, the third would show the aggregated markets, with the curves added horizontally. The profit the firm gains from each market is determined by the difference between price and marginal cost (assumed constant), multiplied by quantity. Assuming the firm is a profit maximiser, this quantity is determined where MC=MR. On the diagram, the areas showing profits for the two segmented markets should be larger than that of the combined market. Therefore, profits are higher for the firm when they charge different prices to the different markets - which is third degree price discrimination!