The Bad Economist

Price Discrimination September 28, 2015

I wear my hair short. Like, really short – it’s buzzed on the sides and scissor-cut on top, so that it’s low-maintenance, and I trim my own beard using a storebought clipper. My father-in-law does the same thing – except he pays a little bit less than I do, because he tells the barber he’s old and cheap. Why does that work?

A business, we assume, wants to make money. As such, it wants to sell its good at the highest price possible to each consumer. Consumers, though, want to spend as little as possible, to maximize the difference between their willingness to pay and the actual price they pay. (Economists call that difference consumer surplus.) Most of the time, it’s difficult to charge people different prices based on their willingness to pay. To do so requires three big elements.

First, the market has to be segmented. This means that consumers have to have different willingnesses to pay. Think about  a price-sensitive consumer like my father-in-law – he’s getting ready to retire. His wife is already retired. He needs to adjust to spending less money than he’s used to. A lot of his fellow senior citizens feel his pain. Meanwhile, I’m a young(ish) guy. I teach at a community college, I have no kids, and I have a long time before I retire (so my money has a lot of time to grow). I’m willing to pay a little bit more for a haircut than he is. In addition to senior citizens, college students are often given discounts just for being students.

Second, there needs to be some element of monopoly power. My barber isn’t a monopolist, because pure monopoly is rare, but I do go out of my way to go to a place where I have a good rapport with the barber. I have a guy who cuts my hair the way I like it, and I like the atmosphere at his shop. Plus, even though I could probably shop around to find a cheaper price if I went somewhere else, I couldn’t find a price that much cheaper. Haircuts have pretty standard prices around here. That’s what the monopoly power condition is intended to enforce – if I get angsty about not getting a cheap haircut, I don’t really have other options.

Finally, the good needs to be difficult to resell. If we were talking about an oil change on my car, I might send my father-in-law into the mechanic’s shop with my car to get the senior citizen discount on an oil change. When we have a family event planned, he buys the bagels because the local place gives him a deal just for being older. Or if my mother is looking to redo the bathroom, or kitchen – my father has friends at http://www.restorationusa.com/west-palm-beach/ who’ll give them a great discount on that as well. It’s impossible, though, to resell a haircut, so I can’t use his senior citizen discount to my advantage here. Baseball and hockey tickets often offer student rush specials where you have to (theoretically) show a student ID to get the discount. Enforcing that would ensure that people with high willingness to pay didn’t buy the cheap tickets in the nosebleed section, but the open secret is that the Mets don’t really care if you buy cheap tickets, as long as you buy tickets.

If those three conditions exist, then it’s possible for a seller to charge different people different prices. Economists call that price discrimination. It’s not necessarily a bad thing, though – it means if you’re cheap, you can get a pretty good deal on some goods.