Snickers, Sweaters, and Price Discrimination

In the present day I proceed my on-again-off-again theme of “Kevin complaining that economists are horrible at naming concepts.” The inspiration for this publish comes from the pricing system utilized by a clothes retailer my spouse loved perusing. 

At this location, objects of clothes carried value tags that had been curiously completely different from what you’ll discover at most clothes shops. Every merchandise of clothes had a number of costs listed on the tag, together with a collection of dates related to the worth. The longer an merchandise of clothes went unsold, the decrease its value would drop – and the date of every lower was listed on the tag. So, a sweater could be marked as $50 right this moment, however on March 1st it could be $40, and on April 1st it could be $35. When she informed me about the entire system, my first remark was “That’s a very intelligent approach to interact in value discrimination.” After which I felt the outdated annoyance inside me about that time period, as a result of what most individuals would suppose when listening to it is extremely completely different from what it really describes. 

Think about speaking to somebody who has by no means studied economics and telling them a selected enterprise engages in value discrimination. What would they seemingly take that to imply? In all probability one thing just like the road within the tune America in West Facet Story, the place one of many singers complains “One have a look at us they usually cost twice.” Or, maybe, one thing just like the reviews one generally sees claiming that houses owned by a black household get considerably greater value determinations if the appraiser thinks the house is owned by a white household. However precise value discrimination is completely different from this. 

Let’s assume that Snickers is keen to promote sweet bars for no less than 75 cents. And assume I’m keen to purchase a sweet bar from Snickers for upwards of $1.25. Let’s additionally assume the market value for Snickers is $1 per sweet bar. Once I purchase a Snickers, I get one thing for $1 that I valued at $1.25, they usually get $1 for one thing they valued at 75 cents. Because of this, I get 25 cents in shopper surplus, they usually get 25 cents in producer surplus. To this point, so good.

After all, what Snickers would like to do is cost me specifically $1.25 per sweet bar, since that will result in bigger producer surplus for them. However whereas they know that some shoppers on the market could be keen to pay greater than the present market value, they don’t have any dependable means of realizing who they could be, and the transaction prices of making an attempt to work that out are prohibitively excessive. If they might reliably determine that they might promote sweet bars to me at $1.25 and $1 for you, they might efficiently be participating in value discrimination. 

So, lets carry it again to the clothes retailer. The workability of value discrimination is determined by the vendor having the ability to reliably know a particular shopper’s willingness to pay. There’s no possible means to try this with Snickers bars. But it surely’s very straightforward to do in, say, an public sale. Auctions, by design, promote objects to the particular person with the very best willingness to pay. After all, auctions don’t assure excellent value discrimination. I would win a Snickers in an public sale by bidding $1.15 – this falls in need of the complete $1.25 I’d have been keen to pay nevertheless it does present Snickers with the next producer surplus than an peculiar market transaction. The clothes retailer, in contrast, operated on a type of reverse public sale pricing system. They’d be keen to promote the hypothetical sweater for no less than $35, however they know that no less than some prospects on the market could be keen to pay extra. If I valued the sweater at $50, I’d in fact nonetheless desire to pay $35 for it as an alternative of $50. But when I await the worth to get that low, I would lose the sweater if another person is keen to purchase it when the worth drops to $40, so that provides me a motive to purchase it earlier than that occurs. By utilizing this method, the shop can guarantee that extra of their gross sales go to individuals who worth the merchandise essentially the most, whereas additionally gaining a bigger producer surplus. 

Value discrimination can be extra possible outdoors of auction-style situations the place sellers are in a position to get extra particular person info on potential consumers. You’ve in all probability heard the recommendation that for those who’re going to purchase a airplane ticket on-line, it’s best to first clear your web browser cache and cookies and consider the web site in incognito mode, or behind a VPN. The explanation for this recommendation is as a result of web sites can use that type of info to interact in value discrimination. As an alternative of promoting tickets at a flat charge to all shoppers, they’ll have their web sites programmed to make use of that info to attempt to decide the utmost value this particular shopper pays for a airplane ticket. Getting access to that info reduces the data asymmetries that exist between purchaser and vendor – I know what my most willingness to pay is, however they don’t. Whereas Snickers doesn’t have a possible means to cut back that hole, another sellers do. That’s why everybody pays the identical value for a Snickers bar, however why the particular person on the airplane seat subsequent to you might need been charged a special fare or why two college students in the identical school course could be paying completely different tuition. 

So the concept is fascinating and helpful – however I nonetheless say it’s terribly named.