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Price Discrimination: You’re Doing It Wrong…

January 16th, 2014 · 9 Comments
Econ 101

Let’s be honest- price discrimination is an important thing to talk about in class, but by the time it rolls around (in a principles course at least) you’re already rushing to cram in all of the material and too exhausted to bother coming up with clever/funny examples to use anymore. (Instructors, don’t even pretend that you don’t know what I’m talking about here.) This is unfortunate, both because knowing why price discrimination is a thing makes a lot of what consumers see in the marketplace make more sense and because price discrimination often gets an undeserved bad reputation, whereas it can actually be used to serve more customers without making anyone worse off. Luckily, I’m here to help!

First, a friendly reminder on what price discrimination is:

On a general level, price discrimination refers to the practice of charging different prices to different consumers or groups of consumers without a corresponding difference in the cost of providing a good or service.

First-Degree Price Discrimination: First-degree price discrimination exists when a producer charges each individual his or her full willingness to pay for a good or service. First-degree price discrimination is also referred to as perfect price discrimination, and it can be difficult to implement because it’s generally not obvious what each individual’s willingness to pay is.

Second-Degree Price Discrimination: Second-degree price discrimination exists when a firm charges different prices per unit for different quantities of output. Second-degree price discrimination usually results in lower prices for customers buying larger quantities of a good and vice versa.

Third-Degree Price Discrimination: Third-degree price discrimination exists when a firm offers different prices to different identifiable groups of consumers. Examples of third-degree price discrimination include student discounts, senior-citizen discounts, and so on. In general, groups with higher price elasticity of demand are charged lower prices than other groups under third-degree price discrimination and vice versa.

Now, let’s think about this second-degree price discrimination situation…one thing you could do is ask your students whether the following scenario makes sense:

In general, firms price discriminate when price discrimination strategies increase their profits. (Shocking, I know.) Mathematically, this implies that price discrimination strategies will involve setting lower prices for consumers who are more price sensitive. But economists generally agree that consumers are more price sensitive (i.e. have higher price elasticity of demand) when the good they are buying comprises a higher share of their budget…and goods usually comprise a larger share of budget when they are purchased in higher quantities. This suggests that higher quantity consumers should be charged lower (per-unit) prices under price discrimination than lower-quantity consumers, right.

Even if you don’t buy this logic, you can always fall back on the observation that consumers can generally buy multiple individual units rather than the larger bundle, so they wouldn’t but the bundle at a higher per-unit price unless they realllllly liked the extra packaging. (And, in fact, if the packaging was actually significant, the scenario wouldn’t even really fit under the heading of price discrimination.) Now, armed with this new insight, consider a second similar scenario, which does in fact control for the packaging issue:

I dare you to devise a reason why an individual would pay $2 to not have 4 more batteries- the only thing I can come up with is that batteries don’t have the property of free disposal, since you aren’t supposed to just throw batteries in the trash and are instead supposed to…well, there’s a process that I’m not entirely familiar with. Therefore, if it takes effort to get rid of batteries, then maybe someone would pay money to not have them show up in the first place. Maybe.

Maybe third time’s a charm, so how about this one?

Is there such a thing as douchebag-degree price discrimination? Maybe I’m just bitter because I’m stuck on the waiting list for the event.

Tags: Econ 101

9 responses so far ↓

  • 1 Norman Maynard // Jan 17, 2014 at 1:58 am

    When I taught intermediate micro, I had them write up short economic naturalist -type papers. One student identified a situation similar to the Playtex example: a combo at McDonald’s that’s cheaper if you buy each item separately.

    His explanation was that it wasn’t second-degree as we might expect, but that it was third-degree. McDonald’s had set up a hurdle where those who care about price would do the math to check whether the combo actually saved money, while those who were not very price sensitive would buy the combo for convenience. As anyone who has taught econ knows, requiring people to do math is a pretty effective hurdle.

  • 2 Omar Mbye // Jan 18, 2014 at 9:55 am

    I ‘m not instructor, but these a bad things, it should not be entertain.
    Ilike ur teaching, u v. good.

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  • 4 Jerry Friedrich // Feb 17, 2014 at 8:12 pm

    Jodi,

    May I propose a 4th degree of price discrimination. In the article above you state that:

    Third-Degree Price Discrimination: Third-degree price discrimination exists when a firm offers different prices to different identifiable groups of consumers. Examples of third-degree price discrimination include student discounts, senior-citizen discounts, and so on. In general, groups with higher price elasticity of demand are charged lower prices than other groups under third-degree price discrimination and vice versa.

    Well, 4th degree is similar but it has nothing to do with price elasticity of demand. It has to do with age. In 4th degree if you are older you pay more than someone younger who pays less for the same product. You say, this is not possible? Well that is the exact logic that exists in the pricing in the Affordable Care Act. The difference now is that all plans have the same basic coverage making the only difference age.

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