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How do producers charge different consumers different prices? September 29, 2015

Posted by tomflesher in Micro, Teaching.
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Price discrimination is the act of charging different consumers different prices based on how much they’re willing to pay. There are a few different forms of price discrimination, and it can be achieved different ways depending on how much information a seller has.

Haggling, or negotiating to find an exact willingness to pay, is an effective form of price discrimination for large purchases. For example, a car salesman can often start with a high price, and when the customer refuses, he can incrementally lower the price (or otherwise adjust the offer) until he find a deal that the buyer is just barely willing to accept. This has one huge advantage – it gets the most that the customer is willing to give up (or, in other words, it extracts the customer’s maximum willingness to pay). It is, however, very costly for a salesman. Just imagine if the salesman were to spend a whole day negotiating only to realize the buyer wasn’t willing to pay enough to cover the cost of the car. Then, the salesman loses the chance to make a sale at all that day. Since it’s costly, this method is most useful for high-priced items like cars and houses.

If you ask a consumer what he’s willing to pay, he’ll lowball you; haggling helps force the price (and the profit) up.

Direct segmentation allows a market to be broken up based on some visible characteristic. In the previous post, I discussed my father-in-law’s senior citizen discount on haircuts and how he pays less than I do for the same cut. He does this by asking for a senior citizen discount, which I’m not eligible for.

Direct segmentation involves breaking the market up into different groups and intentionally charging different prices to those different kinds of people. It works best when one group has a higher willingness to pay – so, since I’m not a college student, and not a senior citizen, my (relatively) high income means I don’t ask for a discount. Similarly, I pay a lower price to have my blazers dry-cleaned than my department chair does, even though her blazers are made up of a smaller amount of fabric. Dry-cleaners just automatically charge a higher price for a woman’s garment than a man’s, even if the garment is similar.

This sometimes leads to unpleasant outcomes. NPR did a story on a 12-year-old girl who had to pay a premium to play Temple Run as a female character; non-white-male characters were all in-app purchases that cost money.

Indirect segmentation is like direct segmentation, but requires the consumer to do some work to get the lower price. A good example of this would be a volume discount. I have a strong preference for Crayola An Du Septic dustless chalk. (I like its weight and erasability.) When I purchase chalk to use in the classroom, my buying options include paying about $3.50 for a single box or about $12 for a 12-box package. No sane person who isn’t a teacher has any use for 12 boxes of blackboard chalk, so I signal my price sensitivity by buying a larger amount at once.

Another way people reveal their types is by clipping coupons. A coupon is like a little badge that says “I’m cheap! Give me a lower price!” By doing a bit of extra work to signal my cheapness, I qualify myself for a lower price just as much as if I’d haggled with the guy behind the counter.

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