Price discrimination is a strategy employed by monopolists to maximize profits by charging different prices for the same good to different customers based on their willingness to pay. This concept is distinct from social discrimination, as it focuses solely on economic factors rather than personal characteristics. For price discrimination to occur, three key conditions must be met:

1. Market Power: The firm must possess market power, meaning it can influence the price and quantity of the good sold. Monopolies inherently have this power.
2. Market Segregation: The firm must be able to segment the market into distinct groups of consumers who exhibit different price sensitivities. For example, students typically have a more elastic demand compared to small businesses, meaning they are less willing to pay higher prices.
3. No Resale: There must be barriers preventing customers from reselling the product. If customers could buy at a lower price and sell to others at a higher price, the monopolist would lose potential profits.

Consider the example of Microsoft selling software to two groups: small businesses and students. Small businesses, having a more inelastic demand, are willing to pay a higher price for the software, while students, being more price-sensitive, require a lower price to make a purchase. By charging small businesses a higher price (P_SB) and students a lower price (P_ST), Microsoft can maximize its profits. The economic profit is represented by the area between the price charged and the average total cost for each group.

In this scenario, if Microsoft charged a single price, it would either lose sales from students or forgo potential profits from small businesses. By effectively segmenting the market and applying price discrimination, the firm can increase its overall profit while still catering to both customer groups. This strategy illustrates the importance of understanding consumer behavior and market dynamics in maximizing revenue.