Price Discrimination Explains Everything

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A commenter writes,

Standard economics that is taught in intro economics says that higher prices induces greater supply. Under certain restrictive assumptions that is generally true.

But there are exceptions. One is when the bulk of the firms costs are fixed and variable costs are a minor cost of bring the product to market

I tend to think of this as the rule rather than the exception, and I agree that introductory economics classes should give it more attention. I would say to my high school econ students that price discrimination explains everything. By that, I mean that in real-world business, the challenge is often recovering fixed cost. Marginal cost is often low, so you want to charge a low price for use on the margin. But you want to try to extract a high price from people willing to pay.

For one example among money, if you are a cell phone service provider, rather than charge the same price per unit of data for all customers, you try pricing tiers. $X per month for 0-2 gigs, $Y a month for 2-4 gigs, etc. You are trying to recover more of your fixed costs from the big users, and at the same time your users feel that the marginal cost is zero, at least until they bump up against the next tier of usage.

Cable company bundling is another classic example of price discrimination explains everything. So are store coupons. So is the price of popcorn at movies.

4 thoughts on “Price Discrimination Explains Everything”

  1. Your commenter’s principle, “higher prices induces greater supply,” is a pure example of “reasoning from a price change.” Perhaps what he means is that a rise in prices *caused by a shift in the demand curve, with no change in the supply curve*, induces a greater amount supplied (= a greater amount demanded); thus the shift in the demand curve should really be considered the “inducer”–the cause. But even this amended principle will not hold if the shift in the demand curve is expected to be merely momentary. Production decisions are driven by expectations about the *future* demand curve, changes in which are what drive changes in amount supplied/demanded. (My comment has no relevance to your point about price discrimination, which seems too sophisticated a notion for Econ 101–maybe 102?)

  2. It’s amazing how powerful a little knowledge of price discrimination is. My firm invests in ~100 pre-seed stage technology startups per year. I’d say my 10-min spiel on price discrimination, wherein I explain that the entire goal of a tech startup after it figures out it can build something that people want is to figure out a good price discrimination scheme, is about the 3rd most popular of my many 10-min spiels (how to build a pitch deck and structure a next round of funding are the top 2).

    Founders’ eyes light up when I reveal that the price of feature packages used for discrimination do not in any way have to be related to the technical difficulty of implementing those features (I point out that children probably enjoy movies more than adults but get a better price). Most of these founders are highly educated, some with MBAs. But price discrimination, at least this practical perspective on it, is new to most of them. I am grateful to the econ blogosphere for reminding of this years ago.

  3. International disparities in drug prices is another. Which brings up an important corollary point.

    The trick to effective price discrimination is some reliably mechanism to prevent arbitrage that puts up effective barriers to resale.

    For some products the mechanism is internal: Verizon doesn’t let me sell you a few extra gigabytes, the products are virtual, phones are coded to prevent use on other networks, and everyone has to deal exclusively with the central entity in hub and spokes relationships.

    For other products, especially for physical commodities like pharmaceuticals, the mechanisms are legal, e.g. patent and FDA-approval-based monopolies, criminal penalties for unlicensed dealing, and re-importation bans.

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