Price Discrimination - Are We Being Exploited?

By Heather, Ken | Teaching Business & Economics, Autumn 2002 | Go to article overview

Price Discrimination - Are We Being Exploited?


Heather, Ken, Teaching Business & Economics


INTRODUCTION

Whenever you travel, because you are interested in economics you are probably conscious that you are being charged a different price for your journey than some other persons travelling with you. A rail journey is cheaper in the middle of the day than it is in rush hour. However, even at the same time of day a range of prices is being charged. For example, some have rail cards entitling them to discounts; others do not. Children often travel at half price. It is cheaper for people who book in advance. If we travel by air the price of the ticket probably varies hugely between types of traveller. These variations occur not just for different airlines and different flight times but people travelling on the same aircraft have bought tickets for very different prices. Some will have paid no money at all if they have collected enough `air miles'.

These price differences are not confined to the transport industry. The rates charged at hotels vary between customers even for the same quality of room on the same night. Doctors in the private sector charge different amounts to different patients for the treatment of the same condition.

Although such behaviour has been around for a long time, people are becoming more aware of it, perhaps most of all as a result of the arrival in recent years of the low cost airlines such as easyjet and Ryanair.

Charging different prices to different customers for the same good is known as price discrimination. However, as we shall see, not all the examples quoted above fall into the category of price discriminatory behaviour.

Most people, including many students of economics, find the behaviour of firms in this respect to be unfair. They instinctively feel that it is only fair that people buying the same product should pay the same price. In this article we will attempt to examine these issues by looking at three questions. First, we consider what price discrimination is. Second we will think through the conditions necessary for firms to be able to behave in this way. Third, we will consider whether price discrimination is in some way against the public interest. Our first task is to be clear about what price discrimination is.

WHAT IS PRICE DISCRIMINATION?

Understanding the meaning of price discrimination is much trickier than it might first appear. A typical textbook definition that provides us with a good starting point might be as follows:

"Price discrimination occurs when a firm charges different individual buyers or groups of buyers different priced for the same product for reasons unrelated to production costs."

a) Production Costs

The question of production costs is important. Choosing different prices for products because firms have different costs of producing them is not price discrimination Clearly therefore, charging first class passengers more than second class passengers is not price discrimination. Even though the difference in cost may be small it does cost an airline more to provide a first class seat. There is greater leg room and therefore a more comfortable journey. But there is an opportunity cost. The airline can fit in fewer passengers. The higher price is charged because the first class passenger must cover the higher costs.

A less obvious example might be a coastal hotel's policy of charging more for rooms with a sea view. There are no extra costs of cleaning the room or providing the breakfast that often goes with the room. We might therefore think that this is a price difference unrelated to costs. However, the cost of acquiring the hotel, or land on which it was built, was greater for the hotelier because it was on the coast. The sea view costs the hotel more because it has to pay more interest on the money it borrowed to acquire the site. It therefore charges higher prices to those whose rooms have the sea view.

On the other hand different prices are charged when there are no differences in production costs. …

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