Supports: Microeconomics and Economics, Chapter 15, Section 15.5, and Essentials of Economics, Chapter 10, Section 10.5
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A national provider of cable television and internet service has been frequently criticized by customers on social media for using the following business strategy: The company raises its prices every six to nine months. Any subscriber who calls to complain is offered a discount off of the price increase. Analyze how this strategy can be profit mazimizing for the company.
Step 1: Review the chapter material. This problem is about firms using price discrimination, so you may want to review Chapter 15, Sections 15.5
Step 2: Answer the question by explaining how the cable company is using price discrimination to increase its profit. Price discrimination involves charging different prices to different customers for the same good or service when the price difference isn’t due to differences in cost. Firms who able to price discriminate increase their profits by doing so.
We’ve seen that there are three requirements for a firm to practice price discrimination: 1) The firm must possess market power, 2) some of the firm’s customers much have a greater willingness to pay for the product than do other customers, and 3) the firm must be able to segment the market to keep customers who buy the product at the low price from reselling it. Cable companies can meet all three requirements. Cable firms possess market power—they aren’t perfect competitors. Some customers have a higher willingness than other customers to pay for cable service. In fact, many people have become cable cutters and prefer to stream content rather than watch programs on cable. Finally, someone who receives a lower-priced cable subscription can’t resell it.
To increase profit by price discrimination, a firm needs to charger a higher price to customers with a lower price elasticity of demand, and a lower price to customers with a higher price elasticity of demand. People who call up to complain about an increase in the price of a cable subscription are likely to be more price sensitive—and, therefore, more likely to switch to a competing cable company or to cut the cable and switch to streaming—than are people who don’t complain about the increase in the price of a subscription. In other words, the complainers have a higher price elasticity of demand than do the non-complainers and receive a lower price. We can conclude that this business strategy is an example of price discrimination and will increase the profit of the cable company that uses it.
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