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Companies Find Variety of Prices to be the Spice of Life
Subject Price discrimination
Topic Monopoly
Key Words Price, vendors, consumers, posted price, bargaining, technology, revenues, prices
News Story

It was only in the nineteenth century that the idea of charging consumers a common posted price caught on. Of course, some vendors continued to give certain consumers "a special price", even if it was questionable how special the price really was. But even this waned as no-haggle prices were introduced in some businesses where bargaining had always taken place.

However, as technology improves and enables companies to maximize revenues by changing prices over time or charging different customers different amounts, we are returning to differential prices in some markets, such as groceries, mortgages, and computers. To be able to do this, companies need to separate different consumer groups.

Airlines can do this because they can distinguish between those booking early and those buying their ticket at the last moment. Rental car companies can do the same. Dress stores can sell essentially the same piece of clothing but make minor changes and charge different prices. Mortgage companies can use computers to make fine distinctions in the riskiness of loans to different applicants, and thereby charge different interest rates. Dell Computer Corp. has different Web sites for small firms and local governments. Grocery stores typically charge three prices: the posted price, a lower price to those with coupons and yet another price to those with frequent-shopper cards. By analyzing data, stores can decide which prices to raise which to reduce in order to maximize revenue.

The constraint is what consumers are willing to put up with. When Amazon.com was caught charging different prices on the same day for the same DVD, there was uproar. There may also be limits to the extent to which consumers will share information that can be used to maximize revenue.

(Updated September 1, 2001)

Questions
1. The news story identifies a trend toward price discrimination.
a) What two conditions need to be present to allow firms to engage in price discrimination?
b) Refer to the new story and explain how these conditions are met in one of the product markets described.
2. Suppose an airline has a monopoly on a certain route.
a) Draw a diagram of the airline's equilibrium. Be sure to include the marginal and average total cost curves and the demand and marginal revenue curves. Mark the equilibrium output and fare.
b) Show how charging a higher-than-equilibrium fare to passengers who book late increases revenues.
c) What are the implications for profit?
d) Would selling above-equilibrium numbers of seats at below-equilibrium prices make sense for the airline? Why?
3. Consumers may be upset at differential prices. Why? Consider your diagram and the amount of consumer surplus.
Source David Wessel, "How Technology Tailors Price Tags," The Wall Street Journal, June 21, 2001.

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