"A Beautifully Misleading Mind"

The Technology of Price Discrimination

Price Discrimination has been a practice of business owners for a long time. Jane Black in “Sharper Tools for Discriminatory Pricing” talks about the use of price discrimination as early as the late 19th century, particularly in the railroad industry. She explains that railroads used a type of price discrimination known as “versioning” in which they would offer lower prices for carriages that were less nice, sometimes so bad that someone would feel it was worthwhile to pay more. Price discrimination is a very appealing strategy for firms who look to be able to attract customers depending on their willingness to pay. Capturing consumer surplus, Jane Black points out, makes trade more efficient.

Today, technology is making it easier to use differential pricing. Black notes that in the past, first-degree price discrimination had always been regarded as the ideal because it induces maximum production. This ideal, however, has always been unattainable. Now, technology is making it seem like more of a possibility, by making it easier for firms to track information about their customers. Technology has also increased the sophistication of price discrimination when selling products. Coca-cola for example, tested a vending machine that would raise prices on a hot day, and lower them when it was cooler. Amazon has also experimented with using the data it collects on customers to create “personalized bundles…to induce people to buy more.”

While price discrimination is a technique firms will continue to use in the future, consumers have long been bothered by the idea of differential pricing. Black states that people are concentrated on the issue of fairness, and paying more for a product than others makes people feel cheated. Despite these concerns, Andre Odlyzko, the director of the University of Minnesota’s Digital Technology center, explains that price discrimination will continue to grow over the next decade “due to continued ability to find out just how much people are willing to pay and the desire to control how products and services are used.”

by Christopher Hildner, Bradley Fromm, and Carter Mann
http://www.businessweek.com/technology/content/jul2003/tc20030731_6139_tc073.htm

Oh~ The Choices!

http://www.washingtonpost.com/wp-dyn/content/article/2007/01/29/AR2007012900085.html

A couple of weeks ago, Microsoft, the leading desktop operating system software provider released its newest OS, the Windows Vista. And just like its predecessor Windows XP, Vista comes in a range of functionality levels. There's the Home Basic edition, which basically offers nothing significant but just a few twinks here and there for $100. You'll have to dish out another $60 on top of what you have to pay for Home Basic to get Home Premium if you actually want to see the new User Interface called the Aero. Then there's the Business version, which offers better network and hardware stability. And at last, for a hefty $250 you can get Ultimate! Woohoo~. Quite the spread in prices considering the fact that from the producer's point of view, all they had to do was turn off certain features otherwise known as 'crimping'. But what can you do? Microsoft knows there are distinct markets out there for their operating systems. Third Degree Price Discrimination at its best. When was the last time you saw a computer not running Windows (except those who actually bought a mac..HAH)? For the average consumer, no Windows means no computing. There aren't many softwares out there programmed for operating systems other than Windows and Mac, if any. If a consumer decides to buy Vista, he is placing himself in one of the four markets: 1) low-budget consumer 2) average 3) small business 4) the big show and the humongous corporates. My advice? Stick to XP unless you're dying to see the new visuals.

Posted by Minsoo Park, Seon Hwang, Kristy Choi

Sour BlackBerries

A few days ago Research In Motion Ltd. introduced their new BlackBerry 8800, a product targeted towards business users, only a few months after releasing a BlackBerry for consumers called the Pearl. The new BlackBerry 8800 has a full-keyboard handset, allows users to send email, talk on the phone, listen to music and includes global-positioning-technology system for a cost of $300 after rebate.
After the Pearl had the most successful launch in company history in September, Research In Motion Ltd. took its stylish and multi-media features and simply added GPS technology to create the BlackBerry 8800. The catch - the initial price for a Pearl was $200, meaning that there was a whopping 50% increase to add the mapping and navigation system! This is a clear example of 3rd degree price discrimination as the company is offering almost the same product to two clearly different user groups for different prices: normal consumers for $200 and business users for $300.
Additionally, the new BlackBerry 8800 is only available through AT&T’s wireless unit and includes a two-year service contract with AT&T. This smells like a tie-in sale to me.

Superbowl Aftermath

So we've heard some interesting news after the Superbowl; a Bears fan lost a bet to a friend and he is filing a request to change his name to Peyton Manning... and Circuit City announced that they are going to close down 69 of their stores.

After a series of price wars over flat-panel TVs in the few months leading up to the Super Bowl, Circuit City Stores Inc., the nation's No. 2 consumer electronics retailer, stated on Thursday that it plans to close seven domestic Superstores, a Kentucky distribution center and 62 company-owned stores in Canada to cut costs, switch resources to online sales, and improve its financial performance.

The price war led to a minimum of a 15% price drop for flat-panel TVs, which, despite keeping the price of the TVs much higher than a lot of people's budgets, led to a definitive increase in the number of flat panel TVs sold. This was an example of network externalties at play since the consumer's willingness to pay for a good increased as the number of other consumers buying the product rose. On one hand, this price drop benefited the customers who have been consuming more and more flat panel TVs, but on the other hand, hurt the store itself since the gain in sales could not recoup the loss in profits. Thus, some sort of change was inevitably necessary. This bold move indicated a market re-structure decision based on both cost and non cost determining factors. Tough competition with low gross margins, the need to improve efficiency, and the market size of the industry were the main noncost detereminants of the industry structure.

This decision will further increase the market share of dominant competitors such as Best Buy and Walmart; undoubtedly limiting customers' choices and further exploiting consumer surplus. On the other hand, since online sale service is further expanded, more customers might switch to online shopping due to high efficiency.

on behalf of Pamela Tsang, Thomas Li, and Chi Liu

Unfair Fares?

Commuters in the Washington DC area have been closely following a recent proposal to increase Metro subway fares that has been debated throughout the city in the past few months. While the driving force behind the proposed fare increases is due to budgetary concerns, the pricing scheme that is being proposed clearly has its roots in price discrimination.

Metro has proposed an increase in fares during “high use hours” when many people are traveling. These blocks of hours are during commuting times when people are traveling to and from work. Metro is attempting to generate more revenue by targeting and charging higher fares to commuters who have a much greater willingness to pay for subway service during rush hours than a more casual subway rider that is not under pressure to get to work on time.

Metro is also proposing to generate more revenue by targeting subway riders based on their boarding-station. The proposed fare increases would require riders boarding from high-volume downtown stations to pay an additional surcharge. This would extract the consumer surplus of those that need to travel from the downtown stations.

Not only do these proposed fare schedule changes promise more revenue and a balanced budget for Metro, but they work to reduce problems in the subway system caused by high volume usage. By setting a price system such as the one proposed, Metro allows consumers to self-select into the different price groups based on riding time and station. Presumably, those riders that have the greatest willingness to pay for subway service in high volume situations will pay the higher fare. By distinguishing these consumer groups, Metro hopes to decrease subway usage in areas where volume is a problem.

While this pricing scheme is sound, the overwhelming majority of Metro riders would fall in the “high use” price block. So it’s not surprising that the proposed Metro fare increases were met with outrage from consumers. For now, the proposed fare increases were tabled, for the most part because of the heated consumer protests. Metro is currently looking at other ways to balance their budget. However, many officials believe that a fare increase is inevitable. At least they have a solid pricing scheme to implement when that time comes.


~Chuck Thomas, Brian Rock, Lian Ye, and Zoey Wang

Price Discrimination: Bad or Good?

By Sujin, Priya, Ziad

Many assume hospitals initially charge all patients a price and do not engage in price discrimination like airlines and colleges. As we discussed in class, a firm with monopoly power in more than one product line may have additional opportunities to price discriminate. These industries have high annual fixed costs relative to the cost of producing additional services. Hence the sellers try to maximize total revenue that can be taken from the society. Some sellers in the medical industry wouldn’t sell output below the production costs, unless government regulated like under the Emergency Medical Treatment and Active Labor Act of 1986.

Alternatively, not-for-profit sellers may price discriminate just to cover their allocated total costs while obeying established social ethics. Physicians defend their fees on these ethics; however, economists believe the norm. Authors, Richard Steinberg and Burton Weisbrod presented a model showing that because of truly severe competition nonprofit organizations and U.S. hospitals behave more like profit-maximizing enterprises just to survive in the long run.

For-profit and non-profit hospitals basically have minimum options and little choice to price their services to private payers essentially as profit-maximizing endeavors. How can charging and harassing uninsured patients to pay the highest prices for hospital care be ethical? Or the hospital allowing more discounts on bills for large insurance carriers than smaller insurance carriers with less bargaining power? Some industries wouldn’t survive without price discrimination.

Valentine's Economics!!!

Sometimes a relationship could really equal money when it comes to giving the right gifts at the right moment. With the Valentine’s Day being just around the corner, the $1.13-billion rose market can be of interest to some economists. A recent article by the Forbes magazine explores the complexities of this market including the distribution process, costs incurred, and pricing strategies.

Initially, one might believe that rose sellers practice price discrimination during this peak season. Indeed, the price of roses increases during Valentine’s week, hopping from $12 to $100 a dozen!!! As the main source for roses sold in U.S., Columbian labor costs only $1.59 per hour. When the Columbians are exporting their roses at less than 50 cents per stem, how are the retailers justified in selling roses at such a high price?

There are several factors that must be considered before accusing the rose sellers of intertemporal price discrimination. First, one should carefully analyze the costs in the rose market including maintenance and shipping. As the author mentioned, the rose industry has a complex supply chain. When moving from one stage to the next, the roses need to be watered, refrigerated and delivered. These variable costs can be significant. Having to squeeze their profit margin 90 percent of the year, the rose retailers are forced to price higher during this season.

In ECON 101, we learned that when demand increases, price increases as well. It is estimated that Americans will buy 189 million roses on Valentine’s Day. Any rational seller will definitely raise the price. So where is the catch? If the price increase is way out of proportion with the increase in demand, we might suspect that sellers have ulterior motives in mind. Without crunching the numbers, however, we can not say anything for sure.

Okay, let’s assume the sellers’ price according to their costs, future losses, and the increase in demand. How would they extract extra from consumers? Well, one way is by bundling roses with teddy bears or some sort of low-cost add-ons and charging it at an appealing price level. Perhaps they could also have some premium packages in their selection to distinguish the rich brats from regular customers.

So if you think roses are too expensive for you, I would suggest picking up some DIY skills. After all, loving someone incurs a price! Ačiū.

By Jim Baltz, Wooi Yang Chang, and Brian Gavron

Rebates: Up for Debate

Rebates, in their myriad forms, are a form of price discrimination. We have probably all received them. They allow retailers to keep the price on a good high, but advertise it for a much lower one. They allow retailers obtain more money from the consumer on purchase, with the promise of return a few months later. Some consumers won't even send in their rebate forms and the company will keep the money the consumer paid - over and beyond the advertised price.

Consumers who demand a lower price are separated from other consumers by their willingness to complete several additional steps past purchasing a product and to wait weeks to receive their 'discount' in the mail. While consumers certainly self-select their price by complying or not-complying with the terms of the rebate, and even before this by searching for items that have rebates offered in the first place, the complexity of the situation becomes immediately apparent when companies advertise prices that not all consumers receive (by not completing the rebate process or doing so incorrectly) or when companies simply do not fulfill their promises.

Highlighting their interest in the topic, the FTC will be holding a day of Rebate Debates to garner information concerning best practices and common problems that according to consumers, retailers, and academics. There are companies that do not, as the existence of Rebate Report Card verifies, comply to customer standards. During 2005 the FTC brought a case and won against well-known CompUSA for extending the time in which they delivered on rebate returns without their consumers' knowledge. Similarly, a high level of complaints against the process has prompted some companies, such as Best Buy, to curtail their rebate programs.

What the FTC will conclude concerning rebates remains unknown, though it is likely that the issues presented here will be some of those that they discuss.

Posted by: Tiffany Luong and Vicky Ukritnukun

Amazon.com with New Tricks

If you have ventured on to Amazon.com lately you may have seen one of their latest ploys to get consumers to buy more of their goods. Now each product page has a bundled good for purchase with the good. Before one can scroll down to read the reviews of the product one sees the “Better Together” section. Below is a screen shot from the site with Talladega Nights: The Ballad of Ricky Bobby priced with Pirates of the Caribbean.

Even though it may appear that buying these DVDs together one will save about $21, the price given is actually the price of both movies combined. So is this actually a creative pricing strategy? Buying the two goods together will reduce the average cost of the goods as shipping them together will be cheaper, but the marginal cost is unaffected. Also Amazon.com is known worldwide for having some of the cheapest prices for books and other goods. So by buying both products here one is achieving more consumer surplus and Amazon.com is earning more revenues.

The “trick” here though is that Amazon.com is only providing the appearance of a bundled good as the goods can be separated at no charge on the checkout page. Which brings us back to the question, is this a pricing strategy or marketing ploy?

Posted by Michael Ledwith, Jessica Halper, Drew Muir, and Jake Carter-Lovejoy

Amazon (Price) Warriors

Amazon. com, pioneer and leader in online sales, has some innovative tactics in bundling and tie-in sales. Firstly, Amazon offers free “super-saver” shipping for purchases over $25. Most items the company sells are books, DVDs, and CDs, which are typically priced between $10 and $20, and with standard shipping costs at approximately $5, there is a strong incentive for the consumer to “save” the $5 in shipping costs by spending an extra $5 to $15 on extra merchandise. On a website with such an extensive collection of products, the average consumer has little trouble finding another item she “needs,” and the shipping discount works as an effective personalized bundling discount – a bundle selected by the consumer.

Amazon also uses a second pricing strategy which is slightly less welfare optimizing. When viewing the product information of an item on the website, Amazon lists an option to “buy this item along with …” and lists another, similar or complementary item and the total price for buying both items. This is classic, textbook bundling. The catch here is that the bundled price is usually the same as the price of the sum of the individual items – there’s no discount for buying the bundle. The unwary or harried shopper may be essentially tricked into buying additional items because he thinks himself bundle-savvy. On the other hand, this feature may be effective, even with wary customers, as an advertising tool.

Is Wal-Mart helping itself ? – The Launch of Digital Movie Store

By HoosAdvantage: Kara Ivy Goldberg, Wei (Grace) Song, Cheung Fai Yeung

Topics covered: Price Discrimination, Bundling, Product Cannibalization

Wal-Mart Stores Inc. just announced its entry to the digital download business last week. The launch of this long-awaited online movie store is bringing several impacts to the market and itself.

The biggest impact of this launch may be that it now frees studios to cut deals with other online services. Most studios have resisted signing deals with iTunes in part because of Apple's desire to sell movies at one price. Studios prefer variable pricing such as Wal-Mart is offering, and therefore practice price discrimination in the digital market.

Wal-Mart also said it will bundle some titles, allowing consumers to buy the "Superman Returns" DVD and the digital download for a "small additional price." This bundling act increases Wal-Mart’s market power in both the traditional and digital video businesses. It smoothes the entry to the digital download market and will help extract more consumer surplus.

However, has Wal-Mart considered carefully before this launch? Will this new digital store cannibalize its retail DVD business? "Customers have a growing interest in downloading video content, but complementary and supplemental to buying content on DVD," Kevin Swint, Wal-Mart's divisional manager for digital media, claimed. Wal-Mart reportedly objected when iTunes began selling movie downloads. It was worried that iTunes cut into its DVD business, and now it’s launching its own movie download store? The new online store will sell older titles starting at $7.50, compared with the $9.99 charged by iTunes. Will the cheaper pricing strategy save Wal-Mart from the product cannibalization besides undercutting iTunes’ market share?

"With the health of the DVD business and coming high-definition formats, retail DVD business will remain strong for quite a long time," industry expert predicted. The business of delivering popular video content on-demand over the internet is small and growing, but becoming increasingly competitive and complicated. Whether Wal-Mart can translate its success on the ground to the digital domain remains to be seen.

Source: The Washington Post

Wal-Mart launches video download service

Wal-Mart to launch Digital Movie Store

Toyota - Oh, What A Feeling! Lexus - Oh, What A Stealing?

Why cruise along in a $61 000 Lexus LS400 and not a $25 000 Toyota Camry? Are the cores of Lexuses "every bit a Toyota" as The Car Man claims onThe Auto Channel Discussion Board ? Why would Toyota/Lexus compete against themselves? Does this count as product cannibalism? Have we asked too many questions?

The claim is made that "the core of the vehicles of Lexus are every bit a Toyota". They have the same manufacturers, the same dealership locations, and (at least in 1999) the same 'TOYOTA' text imprinted on the window glass. There are no crossover products. Toyotas and Lexuses may not even be considered the same market. Lexus owners may be trying to buy something more than the car itself.

It is our view that they are not competing against themselves.

While opponents of The Car Man had previously argued that the fact that Toyota and Lexus do not have any crossover models illustrates that the two brands are indeed different, this author argues that the lack of crossover models indicates that the two are really just one brand.

This argument illustrates an interesting aspect of product cannibalism. "Product cannibalism occurs when one product category steals potential customers from another product category" according to an editorial from Penn State's Distance Education website.

In this light, the author's argument about crossover models makes sense – if Toyota/Lexus made crossover models, the company would be competing between their own models – they would be stealing potential customers from another product, but since this product would also be part of their company, it would be of no use to the company.

As The Car Man says (and Team Awesome begins to think of him as "Our Car Man"), "Why would [the company] want to spend double the money in resources and advertisement to try and attract buyers to compete amongst themselves?"

What Lexus is doing to Toyota may also be defined as competitive displacement by Soren Kaplan. While it may not be the radical product cannibalism of infinitely updating browsers, it seems slightly tinged with competitive displacement and market invention.

The situation illustrates competitive displacement in that luxury cars (Lexus) and more economical cars (Toyota) do not belong in the same market if you look at cross-price elasticities (as we did in class for the demand for cars) and market invention.

Lexus and Toyota are certainly price discriminators, if not product cannibals.

- Jon Carrier, Joyce Chang, Dexter Galozo, Vinu Ilakkuvan

Metro Contemplates New Pricing Scheme

The Washington Area Metro Transit Authority struggles to balance its budget year in and year out. Metro periodically rolls out new pricing schemes in an attempt to balance its budget, and there is a new proposal on the table. Metro is considering increasing fares for rush-hour riders who exit Metro in the heavy trafficked business district in downtown Washington. Metro is trying to divide the market into two groups: business riders and non-business riders. With this new proposal up for consideration, Washingtonians have been speculating about the wisdom of metro's current fare rates. Recently, Dr. Gridlock addressed a reader's opinion in his column in the Washington Post. The reader suggested that Metro should eliminate its peak-load pricing scheme with higher rush-hour prices, and charge the rush-hour price all the time to try to increase profit. Dr. Gridlock makes a valid point in saying that the rush-hour customers are paying for a more-frequent service. While this is a true statement that Metro has higher costs during rush-hour because of a more frequent service, Metro's main justification for using peak-load pricing is more likely because the demand curve is more inelastic during rush-hour. Metro can make more profit by increasing fares during rush-hour, and offering lower fares during non-peak hours when demand is more elastic. The new proposal to use a pricing scheme with higher price for business riders will likely increase Metro's profit, or more accurately reduce its loss. The use of trip exit station for market division is a smart way for Metro to move towards a balanced budget. However, some people are concerned about this plan, including Dr. Gridlock. Dr. Gridlock suggests this new plan is unfair price gauging, that Metro rider's don't have a choice, "unlike the form of congestion pricing in which drivers get to pick between a free lane or a less crowded toll lane." But Metro riders do have a choice, they can drive or carpool among other options, and for many riders even with fare increases Metro is a better deal than the alternatives, and therefore riders will continue to ride Metro.


Posted by Adam, Amy, Braden, and Fabio

Minimum Credit Card Purchases -- This is Discrimination!

Recently, more and more businesses, such as restaurants, bars, and movie theaters, are requiring a minimum credit card purchase which can force consumers to pay more than what their purchase is worth. This practice is said to be driven by the cost of running the transaction, but often the minimum credit card purchase can range up to $20, which seems to suggest that these minimums more than cover the associated transaction costs. This practice can be seen as a form of price discrimination as it allows firms to classify consumers into groups based on those that are more willing to use credit for small purchases and those that are more willing to use cash for small purchases. One of the main differences between these groups is how the consumers value the relative ease of tracking transactions. Consumers who use cash are more able to easily track transactions, while those who use credit seem to be less concerned with tracking small purchases. Credit card users can be classified as more price inelastic for the given good, and therefore firms implement minimum charge requirements to make them pay a higher effective price. This practice of price discrimination allows firms to transfer more consumer surplus to profits, but it may actually violate credit card company regulations! Visa and Mastercard both prohibit minimum charge amounts, and “American Express’s regulations do not explicitly prohibit minimum charges, but its policy is to discourage any merchant practices that create a ‘barrier to acceptance.’” One of the main advantages of credit cards is convenience, and these minimum charges may punish consumers for using credit cards. Also, the fact that minimum charges vary from business to business suggest that is up to each individual firm to specify their minimum charges. It remains to be seen if businesses will change their policies according to the consumer’s credit cards, but this form of price discrimination may be less than fair.

Posted by Charlotte Pool, Josh Bennett, and Jeff Kerestes

Stop Whining Europe: Gazprom Flexes Muscles

Russian natural gas giant Gazprom has been criticized by western nations for abusing its market power. Russia's largest company controls 93% of the Russian market and holds 16% of the world's natural gas reserves. The company owns more pipelines than any other in the world and caused a stir internationally when they threatened to shut down a pipeline that ran through Belarus towards Europe if the Belarusians did not accept a two-fold price increase.
Gazprom is the sole supplier to many of the countries of the former Soviet bloc. It also supplies the European Union with 40% of its natural gas. The company has been accused of using its monopoly like power in Europe to blackmail other governments.
The Russians announced at 10 am on January 1 they would shut down the pipeline through Belarus if the country did not agree to new terms. Gazprom not only raised the price, but also demanded sale of 50% of the pipeline, which had previously been owned by the government of Belarus.
Is this really Gazprom abusing its market power or are they just executing price discrimination. Belarus has one of the weakest economies in Europe and its economy is dwarfed in particular by Western Europe. The price that Belarus is paying is still below the market price. Belarus pays the lowest price while other countries like Ukraine and Georgia do too.
So why is Gazprom providing subsidized gas to Belarus and other former Soviet states? The obvious answer is the political motives that have continued to exist since the Cold War. However, with this case and a similar instance in Ukraine last year one could see things differently. Gazprom is soliciting only financial benefits, not political ones. The reason Belarus pays less are based on its weak economy (weaker demand) and its important position as a transit point that makes it valuable to Gazprom. Western Europe can complain, but Gazprom is acting like any monopoly would.

Posted by Joe Saunders, Risto Keravuori, Cheryl Kong

Hey Mac! Get out of my Vista...

Though after watching the above commercial (and those like it) an ignorant observer would never believe that a Mac user would ever want to purchase a Windows based computer (or even interact with the Windows OS in any way, shape or form, since they are much to “cool”) there are Mac users which currently use Windows XP on their Macs. As many of you know, Microsoft has recently released Windows Vista, the newest version of Windows, for which there are 4 distinct (and distinctly priced) versions: Home Basic ($199), Home Premium ($239), Business ($299), and Ultimate ($399), from which users are able to choose based on their needs. According to this article published on MacWorld.com though, Microsoft is furthering its use of price discrimination by forcing Mac users which want to run Vista on their computers to purchase either the Business or Ultimate versions (the two highest priced!) by including a clause in the EULA (End User License Agreement) for Vista which forbids the installation of either Home version on a non-Windows based PC. While Microsoft’s decision to publish four distinct versions of its own product for the Windows based PC could be the subject of research on price discrimination product cannibalism, taking a quick look at price discrimination for Mac users is very interesting.

How does this price discrimination affect Macintosh users though? They surely don’t NEED to install Windows, and if their reservation prices are below those of either Business or Ultimate edition then they are effectively priced out of the market, right? Not so fast. In his blog, Tom Bozzo, an economist by trade, states that he will not be installing Vista on his home computer (a Mac) due to the price, since it is nonessential to anything he does at home. He does mention though that “I work in an otherwise all-PC shop, and we have Windows-only licenses for some job-critical third-party software,” and that he therefore must install either the Business or Ultimate edition in his office.

This scenario is what Microsoft had hoped for; considering that their company statement on the issue reads “Home users have rarely requested virtualization and so it will not be supported in Microsoft Windows Vista Home Basic and Home Premium SKUs.” Microsoft believes they can extract much of the consumer surplus from businesses who would normally buy the Home Basic version, just so that they could run their third party programs which run only on a Windows OS, but have much higher reservation prices than $199, since there are no substitutes to Windows in this case. By forcing businesses to purchase the higher priced versions, Microsoft is extracting much of the consumer surplus that would exist if these businesses were able to purchase the cheaper versions. They believe that this increase in producer surplus will outweigh the loss of producer surplus from people who use Macs in their home who are priced out of the market due to price discrimination. While this may be good in theory, it will be a while before we find out of Microsoft has effectively priced an entire portion of the population out of the market, or if they have designed a price discrimination strategy which will extract a significant portion of the consumer surplus.

USPS Goes Postal on Shipping Rates

The United States Postal Service beginning in May will undergo a dramatic change in the way it prices for packages. The current system charges postal customers based on the weights of the packages they are sending. The new system will introduce a system of rates based not on weight but rather on shape. The logic behind the idea is that charging based on shape will give a more accurate payment relative to the cost of mailing packages. The economic side of all this is that the post office will be essentially sorting its consumers, mainly in the form of businesses, and charging them prices based on the elasticities of their demand curves. For example, the company that needs (or doesn’t care/want to change) 9X12 envelopes instead of the cheaper standard #10 envelopes will be charged more than the more flexible/elastic company who shifts its mailing to adopt to the now relatively cheaper #10 envelopes. Another example in which sorting will occur is that under the new plan the second ounce of a first class letter will be cheaper than the first. Those companies that are more flexible and combine mailings will benefit in that they will receive a cheaper per ounce rate. At the same time the post office will identify the consumers with inelastic demand for strictly one ounce first class letters and charge them more per ounce than those willing to adapt to the new pricing. In these ways the new pricing scheme can be seen as second degree group pricing discrimination.

HW 2 Elite Economists (Melissa Berry, Pat Di Gregory, Patrick Giesecke, Jonathan Sutton)

Students Feel Pain of Textbook Price Discrimination

Every semesters, college students flock to the campus bookstore for textbooks while bitterly complaining about the price. According the GAO, a college student spends roughly $900 a year for textbooks alone. To make matters worse, prices of textbooks grow twice as fast as the rate of inflation. The textbook publishers set their prices so high because of price discrimination. In the United States, publishing companies charge a high price while a lower price is charged for the same book in other countries

Publishers own a monopoly because students must adhere to class syllabi; thus the first condition for price discrimination is met. Students often try to maneuver around paying full price such as buying the book used or buying a cheaper international version. The publisher utilizes certain practices in order to allow for price discrimination remains. By constantly introducing newer editions, used books become obsolete, and, therefore, the publisher eliminates arbitrage, the second condition for price discrimination. Publishers also bundle textbooks with extraneous features such as CD-ROMs and Internet companion sites in order to justify such a high price. Since foreign countries are relatively less wealthy than the United States, publishers will often produce lower-priced, international versions. This satisfies the last two conditions, namely two identifiable sub markets and different price elasticities of demand. The international editions come with a token warning on the cover that forbids them from being re-sold in the U.S. even though it is perfectly legal. Additionally, the shipping costs and required waiting time further compels students to avoid international editions.

Because the four conditions required for price discrimination are met, it’s no surprise that publishing companies price discriminate. Unfortunately, the students feel the pain. There is the last resort, however, of just not buying a textbook at all! Just hope to pass the class.

Link: Swelling Textbook Costs Have College Students Saying 'Pass'

Posted by: Caryl Huynh, Meghan Magennis, Chris Coyle, Lance Wang