Tag: Price discrimination

Solved Problem: Why Do U.S. Airlines Charge Solo Travelers Higher Ticket Prices?

Supports: Microeconomics and Economics, Chapter 15, Section 15.5, and Essentials of Economics, Chapter 10, Section 10.5

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According to a recent article in the Economist, some U.S. airlines have “started charging higher per-person fares for single-passenger bookings than for identical itineraries with two people.” However, the difference in fares held only for round-trip tickets that included a weekday return flight. For round-trip tickets with a return flight on Saturday, the per-ticket price was the same whether booking for two people or for one person. Briefly explain why an airline might expect to increase its profit using this pricing strategy.

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 why an airline might expect to increase its profit by charging people traveling alone a higher ticket price than the price it charges per ticket to two people traveling together. The airline is attempting to increase its profit by using price discrimination. 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.

In Chapter 15, Section 15.5, we call the airlines the “kings of price discrimination” because they often charge many different prices for tickets on the same flight. One key way that airlines practice price discrimination is by charging higher prices to business travelers—who are likely to have a lower price elasticity of demand—than to leisure travelers—who are likely to have a higher price elasticity of demand. To employ this strategy, airlines have to successfully identify which flyers are business travelers. Someone flying alone is more likely than someone flying in a group of two or more people to be a business traveler. In addition, business travelers often attempt to complete their trips before the weekend. Therefore, people returning from a trip on a Saturday or Sunday are more likely to be leisure travelers.

We can conclude that an airline can expect to increase its profit using the pricing strategy discussed in the Economist article because the strategy helps the airline to better identify business travelers.

Solved Problem: Do Some Cable Companies Engage in Price Discrimination?

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.

The Curious Case of the GE Refrigerators

Is the refrigerator above different from the refrigerator below?

Consumer Reports is a magazine and web site devoted to product reviews. Their November-December 2024 issue noted something unusual about the two GE refrigerators shown above. (The images are from the geappliances.com web site.) At the time the issue was printed, the first refrigator above had a price of $2,300 and the second refrigerator had a price of $1,300: Consumer Reports notes that:

“These look-alike fridges offer equally impressive performance, have the same interior features … and are from the same brand. So why the $1,000 price difference? We don’t know.”

(Note: GE referigators, and many other products branded with the GE name are no longer produced by the General Electric company, which dates back to 1892 and was co-founded by Thomas Edison. Today, GE is primarily an aerospace company and GE appliances are produced by the Chinese-owned Haier Smart Home Company.)

If we assume that Consumer Reports is correct and the two refrigerators are identical, what strategy is the firm pursuing by charging different prices for the same product? As we discuss in Microeconomics, Chapter 15, Section 15.5 firms can increase their profits by practicing price discrimination—charging different prices to different customers. To pursue a strategy of price discrimination the firm needs to be able to divide up—or segment—the market for its refrigerators.

Firms sometimes use a high price to signal quality. The old saying “you get what you pay for” can lead some consumers to expect that when comparing two similar goods, such as two models of refrigerators, the one with the higher price also has higher quality. In the appliance section of a large store, such as Lowe’s or the Home Depot, or online at Amazon or another site, you will have a wide variety of refrigerators to choose from. You may have trouble evaluating the features each model offers and be unable to tell whether a particular model is likely to be more or less reliable. So, if you are choosing between the two GE models shown above, you may decide to choose the one with the higher price because the higher price may indicate that the components used are of higher quality.

In this case, GE may be relying on a segmentation in the market between consumers who carefully research the features and the quality of the refrigerators that different firms offer for sale and those consumers don’t. The consumers who do careful research and are aware of all the features of each model may be more sensitive to the price and, therefore, have a high price elasticity of demand. The consumers who haven’t done the research may be relying on the price as a signal of quality and, therefore, have a lower price elasticty of demand.

If what we have just outlined was the firm’s strategy for increasing profit by charging different prices for two models that are, apparently, either identical or very similar, it doesn’t seem to have worked. Note that the model shown in the first photo above is the one that had a price of $2,300 when Consumer Reports wrote about it, but now has a price of $1,154.40. The model shown in the second photo had a price of $1,300, but now has a price of $1,399.00. In other words, the model that had the lower price now has the higher price and the model that had the higher price now has the lower price.

What happened between the time the issue of Consumer Reports published and now? We might conjecture that there are few consumers who would be likely to pay $1,000 more for a refrigator that seems to have the same features as another model from the same company. In other words, segmenting consumers in this way seems unlikely to succeed. Why, though, the firm decided to make its formerly higher-price model its lower-price model, is difficult to explain without knowing more about the firm’s pricing strategy.