Skip to 0 minutes and 10 secondsCompared to uniform pricing, price discrimination, if well designed, increases the profit of the companies. In the best scenarios, it can also increase the welfare of consumers. But how do you get different people to pay different prices for the same good?
Skip to 0 minutes and 29 secondsWouldn’t we all prefer to pay the lower price if we consume the same good? You bet! Sometimes, price discrimination is based on objective
Skip to 0 minutes and 38 secondscharacteristics of the consumer: lower prices for children, students or for elderly people, for example. Economists call this ‘third degree price discrimination’. It is quite crude, since it is only based on a few characteristics like age or status, which may or may not be linked to the customer’s willingness to pay.
Skip to 1 minute and 4 secondsThink about it: some students, for example, come from wealthy families and have a high willingness to pay to go to the cinema. Why charge them lower prices?
Skip to 1 minute and 16 secondsThird degree price discrimination is not adequate either for the airline manager or the hotel manager who both try to efficiently separate business travelers from leisure travelers. In an ideal world, the producer would know the exact willingness to pay of each customer, and charge each one the maximum price they are willing to pay for the good or service. This perfect knowledge does not exist in real life, but economists have a name for it. It is called ‘first degree price discrimination’.
Skip to 1 minute and 52 secondsIn the real world, what producers need is something in between first degree fiction and the unsophisticated third degree price discrimination. As you can guess, it will be called ‘second degree price discrimination’. Economists are no fun… ‘Second degree price discrimination’ is based on one
Skip to 2 minutes and 14 secondsclever idea: who is best at knowing each customer’s willingness to pay? Well… the customers themselves, of course! So it is up to the producer to find ways to induce the customers to reveal their true willingness to pay.
Skip to 2 minutes and 33 secondsThe way to do this is to offer slightly different products that will appeal to different types of customers. This way, the customers will select themselves the product which they prefer, and pay the corresponding price. Note that the prices can vary widely.
Skip to 2 minutes and 53 secondsThe most sophisticated examples of second degree price discrimination can be found in services, and especially in the airline industry, where this has been practised for decades. In other words, airlines have developed ‘tricks’ to make customers reveal their willingness to pay. For example, did you know that return tickets with a ‘Saturday night stay’ can be much cheaper? A ‘Saturday night stay’ means that there must be a Saturday night between the flight in and the flight out. Why is that? Found it? Well, it is cheaper simply because this type of ticket will appeal mostly to leisure travellers who have a lower willingness to pay, and not to business travellers, who mostly travel during the week.
Skip to 3 minutes and 46 secondsBut the airline industry is not an isolated case. Hundreds of examples of second degree price discrimination can be found in all sectors of the economy. With second degree price discrimination, the producer offers menus of goods or services to customers, and each menu has its own characteristics and its own price.
Skip to 4 minutes and 11 secondsThere may be variations in the good itself, like different seats in a theatre or a train. This can be considered as differences in the quality of the good or service.
Skip to 4 minutes and 24 secondsBut it is often more subtle than that: if you buy a plane ticket, the price you pay for exactly the same seat on the same flight can vary according to the time when you buy the ticket. Companies discriminate according to the time of purchase.
Skip to 4 minutes and 42 secondsWhy? Take a moment to think about it.
Skip to 4 minutes and 48 secondsWho will buy a seat in an aircraft at the last moment? A leisure traveller? I don’t think so… You have it! Only business travellers or people who desperately need to travel on short notice will buy at the last minute or even in the last few days. Leisure travellers usually plan their trip well in advance and can buy their ticket weeks before the flight. By practising second degree price discrimination, airlines get leisure travellers to plan their trip early, in order to separate them from the business travellers who cannot plan ahead.
Skip to 5 minutes and 31 secondsFor a service, the time of consumption is also an important parameter in second degree price
Skip to 5 minutes and 37 secondsdiscrimination: for example, tickets to the cinema are often cheaper in the morning or early afternoon. Why is the price different? Well, in fact, it is not exactly the same seat you are buying here, even if you are watching the same movie. In the morning, there is some spare capacity in the cinemas, and managers would like to fill those empty seats. This is why they offer lower prices. In the evening, capacity is filled, so managers can raise the prices. You can see that there is a link, which will be explored later, between prices and capacity.
Towards product differentiation
Watch this video to discover how companies manage to get different people to pay different prices for the same product… or rather, nearly the same product.
Check the DOWNLOADS section to access a printable version of the slides included in this video.
Join the discussion
By the way, and I will leave it to you to discuss this question: if the goal of cinema managers is to maximise profits, do you think it is a good policy to offer student discounts on Saturday nights?
Try to consider this question from the point of view of the manager, and not the point of view of the student (who is, of course, very happy with this policy…).
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© By ENAC - Nathalie Lenoir CC BY-NC-SA 3.0