Price discrimination: the bane of consumers everywhere

Photo by James Petts. This file is licensed under the Creative Commons Attribution-Share Alike 2.0 Generic license.

If you’ve been to two different branches of the same retailer, one in the heart of London and one in a less central area, chances are you’ve been a victim of price discrimination. The “discrimination” part of this phrase is probably ringing a few alarm bells with you already, but in the end, price discrimination is just another (relatively harmless) way of firms’ seeking to maximise profits, as basic economic theory states that they do. But what is price discrimination? Essentially, what this is is when firms charge different prices to different buyers for the same good or service. This manifests itself in many forms in our daily lives, from our taking advantage of age discounts to the annoyance we feel when paying large amounts for coffee in Leicester Square. Whilst often denounced by many as simply a discrete form of consumer exploitation, I see it as an ingenious tactic employed by firms to yet again slip under the watchful eye of the average buyer; however, the reason you don’t see price discrimination employed in the real world as often as you thought it might have been is because there are a certain set of criteria that need to be fulfilled in order for price discrimination to take place, the first of which relates to price elasticity of demand.

Intuitively, one of the only reasons that price discrimination works in the first place is because different groups of people will think differently about changing their quantity demanded in response to the change in price of a good or service. Hence, a prerequisite for price discrimination to be viable is that the price elasticity of demand (the responsiveness of demand after a change in a product’s own price) by different consumer groups is different. If the price elasticity of demand for a product were to be similar for two different consumer groups, they would both, ceteris paribus, reduce their quantity demanded by around the same amount for an equivalent increase in price, therefore rendering this pricing strategy ineffective. The firm will also need substantial information about consumer preferences to be able to confidently change the prices for the same good for different consumers, which may prove difficult for a number of firms that are strapped for cash and cannot easily carry out the essential market research. The firm must also not be operating within a perfectly competitive market (otherwise any attempt at price discrimination would simply result in the firm’s getting priced out of the market), and with this, there cannot be a great deal of market seepage (whereby consumers buy the good/service where there is a high price elasticity of demand and sell where demand is comparatively inelastic).

As with many business strategies, price discrimination can take many different forms, with their severity denoted by the “degree” suffix, with first being most severe, and third being the least severe. First degree discrimination is when a particular firm produces products for the same marginal cost, but then sells each product at a different price, depending on the consumer. For example, if I were to want to buy a packet of crisps at a Tesco in Harrow, I’d find that the price of a packet would be quite comparatively cheap. Why? Because I’m surrounded by other retailers that could potentially take my money as opposed to Tesco, and more importantly, I, like many others buying a packet of crisps in Harrow, am likely not in any sort of hurry to buy one. If I’m in bustling central London, however, and am running late to meet my friends, then I’d want to buy a packet of crisps as quickly as I possibly can. Here’s where firms can exploit you. Because you’re less willing to look for alternatives in central London than Harrow, firms can charge you a higher price here, due to the price elasticity of demand for this consumer group being lower than it would be in Harrow. This reduces consumer surplus for the consumers in central London, while giving firms higher revenues. Clever, isn’t it?

Let’s now move on to second-degree price discrimination. Basically, this is when the average cost per item decreases when you buy the items in bulk. This can be used by companies who are not able to pick apart consumer groups as well as the ones carrying out first-degree price discrimination, for example. When companies want to shift excess supply due to changing consumer preferences, for example, they could potentially use this form of price discrimination as although profit margins will be hit, they get the double benefit of at least making some profit on the items and also shifting the excess stock that they needed to shift. This is quite frequently also employed in major retailers such as Tesco and Asda and also at restaurants such as McDonalds and Burger King in order to shift stock of items that just aren’t selling very well any more. Second-degree price discrimination is not exclusively limited to these scenarios, however, and could be used in a wide variety of other contexts, although it has to be said that this form of discrimination is probably quite ineffective in general when compared with the former.

Finally, we move on to third degree price discrimination, which is perhaps the most widely employed in everyday life. Unlike the previous version of price discrimination, this relies heavily on differentiation between different consumer groups. Normally, what happens is that a firm (for example a company offering trips to the cinema) splits ticket prices (broadly) into adults, seniors and children, due to the latter two having a higher price elasticity of demand than adults, for whom the cost of a cinema fare is a comparatively small proportion of their income. The firm attempt this only if if they feel that P1Q1 + P2Q2 + P3Q3 > P0Q0, where P1 and Q1 are the price and quantity demanded for adult tickets respectively, P2 and Q2 are the price and quantity demanded for senior tickets respectively, P3 and Q3 are the price and quantity demanded for child tickets respectively, and P0 and Q0 are the price and quantity demanded had there been a uniform ticket price for all ages of people. Given that first-degree price discrimination occurs quite rarely, and second degree price discrimination is comparatively ineffective, this form of price discrimination is the most lucrative for a potential firm to engage in.

So now we come to the question: is price discrimination ethical? Well, it depends. The profit motive is always going to encourage firms to try to maximise their revenues while minimising their potential costs, and this obviously means that some consumers will lose out; however, the fact remains that price discrimination strategies are employed by firms only because they work, plain and simple; they generate more profit than they would have done without these price discrimination strategies, meaning that the targeted consumers are, by and large, still willing to buy goods for which the strategies are employed, even if they don’t know exactly what firms are doing behind the scenes. Simply, this is just another development in the cat-and-mouse game that is firms’ trying to maximise profits and consumers trying to maximise potential utility, and the fact that firms are finding this worthwhile to do shows that we as a society don’t really have an objection to this happening, even when it’s happening right in front of our eyes (as shown in the third degree price discrimination example above). As firms continue to become more and more savvy to make profits, it’s down to consumers to ensure they’re not being continually one-upped by price discrimination.

So consumers, the ball is in your court.

Traffic jams: An economic perspective

You know the feeling.

The skies are grey, and fat drops of rain batter your windscreen: it’s almost as if the sky’s crying for you. You’re stuck in a sandwich of motorised vehicles – progress only comes a few inches at a time, slowly but not always surely. You curse as the faint hope you had of speeding ahead is dashed, falling away like droplets from the sky.

But then, after long hours of waiting, it happens. One car edges ahead, then another, then another. Finally, it’s your turn; your car moves forward, breaking the seemingly endless deadlock. It’s emotional catharsis the likes of which you can only experience after hours of frustration. Finally, you’re home, free from the scourge of traffic (until next morning, at least).

When the adrenaline rush wears off, though, you realise that you just wasted precious hours of your life that you’ll never get back. You could have spent that time watching television, playing chess, or even working more if you had to. In addition to the emotional outrage faced by many drivers across the planet, this congestion also has severe economic consequences for car-owning households. According to The Economist, traffic jams cost Los Angeles $23 billion a year, and that isn’t even when we take into account environmental impact. But why exactly do traffic jams happen, and what exactly can we do about them?

Well, part of the blame for traffic jams lies squarely on the shoulders of the people themselves. Public transport in the form of predominantly buses is a “key mode of public transport for those on low incomes”, according to Transport for London. As incomes go up, naturally the proportion of people using public transport in a particular country will decline. Don’t believe me? Hear me out. Public transport is an inferior service, which essentially means that demand for it decreases as consumer incomes go up. This is natural, as cars are inherently more prestigious than buses or trains; they grant you a degree of privacy and exclusivity, and they almost always look better. Therefore, you’d expect that as people become more affluent, more of them will ride in cars and other private forms of transport. Still don’t believe me? Look at the UK. According to the BBC, the number of cars on the streets of Britain rose by almost 600,000 in one year, with the average weekly wages in the United Kingdom also steadily rising. In this case, the correlation implies a heavy degree of causation. What can be done about this? In truth, not much; people’s opinions are not going to radically change. We could, however, simultaneously create more low-skilled jobs in the cleaning sector and clean up our public transport, which appears to be surprisingly dirty. Cleaning up and renovating some of our aged public transport, thereby making it somewhat more prestigious, could go some way to dampening the tradeoff between consumer income and public transport use, although, admittedly, the effect probably won’t be too drastic. It would help though, so why not try it?

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Improving the quality of public transport could diminish the correlation between income and car use. PHOTO CREDITS: Route 79

It’s also important to consider that as of right now, roads are mostly free at the point of use across the world. Therefore, many people see the use of roads as a given: something for which there is no cost. Hence, the number of cars on the road are surging, as the only thing people actually have to pay for is the payments associated with the car itself and fuel. If governments around the world could somehow introduce a system whereby people are charged for the duration of time that they spend on the roads, demand for cars would fall due to increased price leading to a decrease in quantity demanded, as per the demand curve. This is because an increase in the cost of driving means that for more and more people, the marginal utility gained by using a car is offset by its substantial total cost (in layman’s terms, it costs more than it’s worth). Although this would lead to potential job losses in the auto manufacturing industry, it is necessary to carry out to offset both the economic loss of productivity and the severe environmental damage on air quality caused by traffic jams. In short, while painful for one industry, we need to do this for the greater economic and environmental good.

While campaigns encouraging walking, cycling and use of public transport are almost ubiquitous in today’s world, and have no doubt had their effects, more still needs to be done in order for the prevalence of cars on the roads to decrease dramatically. The difficulty of cycling is one factor why for many, the utility gained in terms of exercise and fitness is less than the cost, in terms of their commute becoming drastically longer and also the safety risk that it entails. What I am proposing to solve this is to build more cycle lanes next to roads, thereby increasing their supply. The increased ease by which many can now find an easy way to cycle to the workplace would decrease the costs of cycling, thereby making the utility/cost tradeoff more favourable, hence spurring demand for bicycles with which to cycle to work, potentially helping the cycling industry also. Given that these cycle lanes take up considerably less space than new roads would, they are both a quicker and more effective solution to the problem of traffic congestion (the increased supply of roads would simply spur demand for cars in the same way as demand for bicycles is spurred above).

Applying economics to the problem of traffic congestion may seem unorthodox at first, but I am convinced that inherently, many of the world’s problems are economic. After applying economics to this situation, it’s entirely possible that you may just spend less time stuck on the roads.

Agree? Disagree? Please leave a comment below, whether you’ve been attracted or repulsed by my ideas.