Price Discrimination - Why some people pay less

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to think like an economist. Now, as I hear, you
have a shopping tip for us.
Yeah, and it's only useful in some places. But an
uncle gave me a tip about going to a market
in the Middle East, and that is to let a
local do the buying. Okay, So why is that Well,
once you look like you're from abroad, the prices magically
go up.
So this is why I can never get a good
deal at the market we went to in this denbul.
It says blonde larks justin.
But it happens. I mean, there are rarely prices on things,
and I think the shopkeeper looks at you and sort
of sussers out how much they think you can pay,
and they milk you for it, which is kind of
clever and good for them.
So economists call this a sophisticated pricing strategy, and that's
the topic for this week's episode of Think Like an
Economist with Me Betsy Stevenson.
And I'm Justin Wolfers. We're teaching you the super tools
of economics that will supercharge your life. Nestra and Tabercoli
Fara is with us.
A sophisticated pricing strategy is a great term.
And it's a great concept, and you don't have to
be in a market in Turkey to experience it. They're
more common than you think. Next time you go to
the movies, look at the prices. You'll often see that
students and seniors pay lists, even though everyone in the
movie theater is getting the same product as they're watching
the same movie at the exact same time.
But I guess not everyone can afford the same price for.
A ticket exactly. So movie theaters do something clever. Instead
of saying you can only come if you pay the
full ticket price, or instead of making tickets cheaper for everyone,
they charge different people different prices. They're trying to make
it so that nearly all of their customers will want
to buy a ticket for the movie, and also so
they get as much money as they can from each
of those customers. This can really boost their bottom line,
making a moderate business super profitable. When a business sells
something at different prices, we call it price discrimination.
So this is really intuitive. Great businesses want to charge
people what they'll pay, and so they want to discriminate
to charge each of their customers the highest price they'd
be willing to pay for a product. So how does
a movie theater do that? Well, they do some research
and they discover that people with jobs might pay up
to twenty dollars for a movie ticket, but students might
only pay up to ten dollars. Economists call this price
the reservation price. The most are customers willing to pay
for a product.
If you follow the cost benefit principle, you'll only buy
a movie ticket if the ticket costs less than your
marginal benefit. And so your reservation pricing is your marginal benefit.
And what if the movie theater charge is twelve dollars
for everyone instead? Can may solve the problem that way?
Well, there are plenty of people willing to pay up
to twenty dollars for a ticket, So that's eight dollars
that the movie theater loses if they charge everyone twelve dollars.
And you know what, twelve dollars is still too much
for students.
Okay, I see this sounds good for a business. It
means they're selling as much of their product as they
can and squeezing as much money from everyone as they
can and do customers benefit from price discrimination.
Some do and some don't, which is why it can
be controversial. If you're getting charged twenty bucks because the
theater figures you can afford it, then obviously you'll resent
paying that higher price. People hate being asked to pay
a bit more even if they can afford it. But
by offering discounts to students, the theater makes it possible
for students to afford a night at the movies, so
they're better off. The upside of price discrimination is that
it makes it possible for more people to benefit from
a product.
Race discrimination is important for some of our most important purchases.
For example, universities usually set a pretty high sticker price.
That's the price they say they're going to charge everyone,
but actually very few students pay that. You know, at
our university, the University of Michigan, the sticker price is
forty nine thousand dollars, But how very many students pay that?
In a recent class, I asked my students how much
tuition they're actually paying this year. I did it in
an anonymous poll. We found out that around forty percent
of them pay less than ten thousand dollars in tuition,
and only sixteen percent pay more than forty thousand dollars.
Universities do this by providing grants and scholarships. Sometimes they're
based on your family's income, so we think of this
as need based you simply can't afford to pay more.
And sometimes they're based on your academic abilities, which are
really nice to win, but really they're just a fancy
word for a university offering a discount.
So by doing price discrimination and giving these discounts, the
University of Michigan allows students who can't afford the sticker
price of forty nine thousand dollars to get a good education.
Our example so far are movie tickets and a college education.
These are really different products. I mean, can you price
discriminate with any product?
To price discriminate, you need to make sure that your
business meets three conditions. First of all, you need market power,
which is what we were looking at in our last episode.
And to recap, a business has market power if it
can charge higher prices without losing many sales to a
competing business.
That's right. So the University of Michigan has some market power.
It's very good universities, so people want to study here.
As a student applying to universities, you only get so
many offers.
Secondly, to be able to price discriminate, you need to
be able to prevent resale. Now, if I sell you
something on discount because you qualify, saye, for a student discount,
you can just resell that product at a higher price
to someone else and keep the difference. Price discrimination only
works if we can prevent you from reselling the product.
Yes, and scholarships or grants which lead to lower university
tuition only get given to a specific person exactly.
Another examples airline tickets. Airlines use price discrimination. Usually you
need to provide ID at the airport, which has to
match your name on the ticket. And note that the
more aggressively a business price discriminates, the more important it
is for them to prevent resale.
Finally, you have to be able to figure out who
to give the discounts to. So you need to figure
out which customers can pay how much you could just
ask people the maximum they're willing to pay, but a
lot of people aren't going to be honest. I mean,
everybody wants a discount, So businesses have to use other
ways to figure it out, and that's what we're going
to look at next.
One of the easiest ways to price discriminate is to
charge different groups different prices. Movie theaters charge students and
seniors less money.
Well, you could say they charge everyone else.
More, Yeah, but they won't admit it because that'll annoy everyone.
They're more likely to say they give discounts to certain groups.
Businesses can charge people different prices according to things like
where they live, how old they are, or other characteristics.
They're trying to divide the market into different groups who
are willing to pay different amounts, and.
We see this in small ways all the time. In
the US, lots of companies offer discounts to people in
the military. They'll say that this is because they're patriotic,
but really they're also charging military members less because it's
the best way to keep them as customers given that
they're probably not earning that much.
So to be able to do this, a business has
to figure out what prices to charge each group, and
they do this with the tools we developed in our
last episode on market power.
Say a movie theater looks at students and figures out
the quantity to sell using the rational rule for sellers,
so they'll keep selling until the marginal revenue for students
is equal to the marginal cost. Then the business looks
at the dems anchor for this quantity and cease the
price they should charge.
Can this thing of charging different groups different prices be dicey?
Though?
Yeah?
I mean it would be pretty outrageous if movie theaters
charged men and women at a different rate. It'd be
a bit of a pr disaster. What businesses need to
do is focus on groups like the military, students, or
seniors where people won't object to those people getting a discount.
And how about universities. When Justin asked to students how
much they paid intuition, he was getting a lot of
really specific numbers.
College is often tailored their discount at each particular student.
When you apply to university in the US, the university
asked a lot of really detailed and personal questions about
your family's income. There's forms. They are many pages long
and they're super pain to fill out, but they allowed
the university to target the discount precisely to you.
These forums help the federal government determine you and your
family's ability to pay for school, and they pass that
information onto the university.
It's important to know that providing discounts based on your
income is pretty rare, so movie theaters tend to try
to group lower income people into categories like students or seniors.
We've been talking about different prices for different groups of customers. Now,
do businesses have any creative ways to figure out who
should get a discount?
Absolutely? So far, we've been looking at groups where you
need to show your age or student card or military ID.
But businesses also let people sort of organize THEMSELVESNS.
What was the last hardbackbook you purchased?
I recently bought the book Money by Jacob Goldstein, who
hosts Planet Money.
And how much did you pay?
I paid twenty eight dollars.
You know that it'll be out in paperback in just
a few months, and it'll be a heck of a
lot cheaper.
I know, but I really want to read this book
and I don't want to have to wait ages for
it to come out and paperback. And also we have
the holidays coming up, and I'll have time to delve in. Then.
A lot of people don't realize this, but that's exactly
why hardback books cost more than paperback books.
Never judge a book by the price of its cover.
What publishers are doing is figuring out who really wants
to read a book as soon as possible, and so
is willing to pay more for it, So they offer hardbacks,
which come out first and typically have a higher price,
and then a few months later offer a cheaper paperback version.
So you're saying the hardback is for the hard core fans.
That's right.
You'll see this a lot. Let's get back to a
movie theater example. You can pay twenty bucks to see
a movie in the theater. We can wait a few
months and stream it for ten bucks and wait a
few more years that you could see it for free
on TV.
This is interesting. You're saying that there's different prices based
on how much you want something.
Now, yeah, we call this pricing method the hurdle method.
A business offers lower prices to people who are willing
to overcome some kind of hurdle or obstacle.
The secret is designing a hurdle so that your high
value customers won't want to deal with it, willing to
pay the higher price, and if you low value customers
do leap over the hurdle, they get the lower price.
The idea is to get people to naturally sort themselves
into groups based on their willingness to pay or their
reservation price.
I'm interested in these obstacles or hurdles that you mention.
So often are hurdles related to effort. Supermarkets are offered
deals all the time. Some products are on discount and
others aren't, and this is changing all the time. You
need to spend some time in the supermarket seeing what's
on sale, what isn't, deciding what to stock up on.
So you only get those discounts if you put in
the time and money to find them.
Now, as you started out by sharing the tip your
uncle gave about markets in the Middle East, well, there's
actually a lot of markets where you can haggle or
negotiate for a better price, and not just in other countries.
You can often haggle with your mobile phone company, give
them a call and threaten to switch providers. Customer service
stuff have some powder price discriminate to give you a
discount if they think you may take your money and
custom somewhere else.
I keep coming by this term hurdle. It almost sounds
like a business is trying to make it hard for
you to buy their stuff.
What they're trying to do is make it hard for
you to get a discount. That way, only those who
really need the discount to make the purchase will go
through the effort to get it. Nas have you ever
noticed that there are a lot of discount retailers of
designer clothes in small, out of the way towns.
Yeah, and they're usually far away from the city center.
Yeah.
So you could walk into a fancy store in the
middle of town to buy a suit let's say it
costs six hundred dollars, which is a lot of money,
or you can travel a few hours to one of
these retail outlets and buy the same stuff for way less.
Sometimes you can pick up the same suit for half price,
like three hundred dollars.
Now, believe it or not, some people can't afford six
hundred bucks per suit. It's not a lot of money
for them, and they can't be bothered to take a
two hour drive out of town to get a discount.
So they'll pay the full price in the fancy store
in the middle of town. The folks who want to
bug and are willing to in the time and effort
to drive out of town and get that same suit
from an outlet store for much less.
So you're saying that cheaper things come to those who
will make the effort.
Absolutely, but don't forget the opportunity cost principle, that time
you're put in to get the cheaper price has value.
Sometimes the hurdle's not time. It's about the quality of
the products. And you might be surprised, but businesses sometimes
intentionally make their products worse in order to create a hurdle.
So take movie streaming. When you go to Amazon, you
can pay ten bucks for the high DEFF version or
six bucks for the standard definition version. Now, the high
def doesn't cost them anymore. In fact, the standard DEFF.
They have to take the high DEFF movie and make
it worse. But the reason they're doing that is to
create a hurdle.
You know, they figure that people willing to leap the
hurdle of watching a movie with slightly lower quality are
those who really need the discount. There's one of their
major type of discount we haven't looked at yet, and
that's quantity. Often buying something in bulk works out to
be cheaper.
So this is like when you go to the supermarket
and you can buy six toilet rolls for nine dollars
or ninety six rolls for fifty two dollars.
That's right. Big families who are up in price sensitive
will be willing to buy all that toilet paper. But
if you live in an apartment on your own, you
probably don't have the space to store that much toilet paper,
so you're probably by the six pack even though it's
not a great deal.
There's also something called bundling. This is when you sell
a bunch of things together and the price for the
bundle is often less than if you purchased everything separately.
Yeah, and I think cable companies do this a lot.
You can get the channels you want, or you can
pay just a little bit more and get lots of
channels in a bundle. The thing is, often you don't
even want all the channels in the bundle anyway.
Yes, and this is smart of them. They get you
to pay a little more for that bundle rather than
getting a bit less from you. If you just bought
the channels you do want.
Let me try to summarize. Businesses often try to get
away with charging different people different prices for the exact
same things. Their big idea is to charge each customer
as much as they can get away with, and that
means charging each customer a little less than their reservation price.
Yeah, and it can be super profitable for a business
and super frustrating for a customer. You know, next time
you're on a plane, you could ask the person next
to you how much they paid for their ticket. But
if you paid a lot, you might not like their
answer because I bet it'll be less than what you paid.
For business, the most difficult part is figuring out which
customers you should charge more and which you should charge less.
The key idea is to figure out who gets the
biggest marginal benefit, because they're the ones who are going
to be willing to pay more.
And is there anything you want our listeners to think
about over the next few days.
My homework assignment is for listeners to look at all
the different ways in which you might be paying more
or less for something than other people. I bet you'll
discover that price discrimination is.
Everywhere, and if you're really smart. Maybe you'll be able
to find a way for you to get the lowest price.
Betsy, justin thank you, Naz, good luck shopping. I hope
that we gave you some tips that help you score
some lower praises.
Here is that price discrimination to your advantage, Nas, She who.
Makes the most effort saves the most money.
And that can be you.
Yeah, but don't forget the value of your time. Yes,
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