Good morning, class. Today we will talk about price discrimination. Time for a PowerNap. Third-degree price discrimination is charging different prices to different groups of consumers with different elasticities of demand. Student and senior citizen discounts fall under this category. There are three determinants of the elasticity of demand:
- The availability of close substitutes
- The proportion of income spent on the good
- The time consumers have to adjust.
The more close substitutes available for a product, the more sensitive consumers are to price and the less able sellers are to price discriminate. The more time consumers have to adjust, the more sensitive they are to price changes and the less able sellers are to price discriminate. The greater the proportion of income spent on a good, the more sensitive consumers are to price changes which makes sellers less able to price discriminate. Since seniors and students, generally speaking, have lower incomes, they tend to be more price sensitive. Thus the discounts.
In a recent article from the Kansas City Star, there is a wonderful example from the world of scalping (from this weekend's MU-KU scrape in Kansas City) where a scalper uses signals to determine whether a consumer has a high elasticity of demand or not. It would seem that #2 in our list is in play.
Three hours before game time, he’d already sold 10 tickets for $150 to $250 each. Now he had two prime seats in his hand. For these, he wanted top dollar.
“How much?” a man asked from inside his black SUV.
“Six hundred.”
“Half that.”
“Can’t do it.”
The SUV moved on, but a moment later another car rolled to a stop.
“They’re $650 for two,” Bill said, upping the price as a young woman and her husband shook their head and then drove away.
“It’s all about the pitch,” Bill said. “Look at the car. Look at the ring on the girl’s finger. Then adjust from there. Don’t worry. I’ll sell them. No problem.”
How cool is that? The scalper took a quick look at his potential customers and made a reasoned guess about their willingness to pay. And notice that the potential consumer moved on.
A student recently asked me about how prices get set in real markets. In our economic models, the prices move seamlessly to equilibrium. Demand goes up, prices adjust up. Supply goes up, prices adjust down. Automatically. Flawlessly.
But we know that's not how things go in the real world. There's a lot of trial. There is a lot of error. But we the people are pretty smart, despite our psychological imperfections. Economic models do a pretty good job at explaining much of what goes on in markets even if the people in markets aren't the perfectly-informed always-rational specimens we often assume they are.