Price discrimination: when is it seen as fair?

Back in 2000 Jeff Bezos of Amazon.com apologized to consumers for a “random price test” in which the same item had appeared for sale on the company’s web site at different prices for different consumers. It appears consumers were upset at the differential pricing.

When I discuss price discrimination (the technical economics term for differential pricing) in class, some students get upset that sound economic theory advocates charging different prices to different consumers (although some of the students are just exercised over my approving use of the term “discrimination”). Clearly, price discrimination raises blood pressure.

Yet differential pricing is everywhere:

You rarely pay the same price for an airline ticket as the person sitting next to you on the flight.

Hotels charge different prices depending on which website you use to make the booking (on a recent trip I found the same hotel room available for $165 when booked directly with the hotel, and $90 when booked on a discount website that does not reveal the name of the hotel until you’ve booked).

When products go on sale, they are technically available to everybody at the same price, but if you don’t or can’t shop on weekends when the sale is on, the same product is being sold at different prices to different people.

A can of cola costs about 25 cents when purchased as part of a 24-pack at a warehouse club, and about $2 (eight times more) when purchased through a vending machine.

Consumers don’t appear to particularly mind these price differentials. In fact, they are considered perfectly normal.

But when my students read in Tim Harford’s discussion of price discrimination that Intel deliberately hobbled its better computer chip in order to sell it at a lower price point so it could serve the growing market for less expensive PCs, they don’t like it one bit. They find it unfair.

Yet exactly the same thing goes on when your cable company blocks out certain channels unless you pay more (all the channels are being piped in all the way to your cable box but some are blocked by the box if you've chosen the less expensive package); or your cell phone provider blocks caller id on your phone unless you buy the “caller-id package.”

Price discrimination exists because it is profitable. It allows sellers to capture demand along different parts of the demand curve.

So companies don’t like it when their price discrimination is turned against them. This happens, for example, when third-parties take up the arbitrage opportunity created by differential pricing and create leakages between markets. For example, when Canadian pharmacies sell Canadian priced medication into the U.S. market where the pharmaceutical companies typically set much higher prices for the same or similar products.

Research on price discrimination has focused on how to maximize profit through price discrimination, and the law on price discrimination has tended to focus on eliminating price differentials as an anti-competitive tool (for example, by charging a lower price to customers of your competitor to drive the competitor out of business).

Behavioral research suggests that consumers consider price differences fair if they are due to differences in cost.*

But that does not quite explain how conceptually similar instances of price discrimination are considered fair in some instances and not in others.

Clearly, we need more research to understand not just when price discrimination is profitable, but also the boundaries beyond which consumers see it as unfair.

*

Daniel Kahneman, Jack L. Knetsch and Richard Thaler (1986), "Fairness as a Constraint on Profit Seeking: Entitlements in the Market," The American Economic Review

Vol. 76, No. 4 (Sep., 1986), pp. 728-741

Lan Xia, Kent B. Monroe and Jennifer L. Cox (2004) "The Price Is Unfair! A Conceptual Framework of Price Fairness Perceptions," Journal of Marketing

Vol. 68, No. 4 (Oct., 2004), pp. 1-15