Ever wonder why the student sitting next to you in the movie theatre paid $20 for their ticket while you paid $30? Or why the flight booked three months in advance costs a fraction of the price of a ticket bought a day before departure?
No it’s not a systemic glitch, and it isn’t just luck. You’ve just experienced price discrimination.
While the word ‘discrimination’ is usually seen as negative, in economics, it is a highly strategic pricing model. In layman terms, price discrimination happens when a company charges different customers different prices for the exact same product or service, based entirely on what they are willing to pay.
A business can’t just randomly assign prices. For price discrimination to work, three conditions must be met:
- Market power: The seller must have some control over prices (a pure competition in a massive, open market can’t easily pull this off).
- Segmenting the market: The business must be able to group customers based on their willingness to pay (e.g. separating students, seniors, and business travelers).
- No sale/arbitrage: The person who bought the $20 student movie ticket can’t tell it to an adult for $15. If customers could easily resell the product, the pricing strategy would collapse.
Economists break price discrimination down into three main categories.
- First-degree (perfect price discrimination/personalised pricing):
- In this pricing strategy, the buyer determines your reservation, (meaning the maximum amount that you are willing to pay), and charges you that exact amount.
- Example: The movie ticket example in the beginning.
- Second-degree (dynamic pricing):
- Most consumers have already experienced dynamic pricing, when prices change due to supply and demand.
- Example: Uber surge pricing when it rains .
- Third-degree (group pricing):
- This is a more accepted pricing system because it’s a more transparent system. This happens when a specific group of people, most commonly students or senior citizens, receive a different rate.
- Example: Student or senior citizens discounts.
So why do companies do it? The short answer is profit. By tailoring prices, businesses capture consumer surplus, the difference between what a consumer is willing to pay and how much they actually pay. If a maths revision course was only sold for $200, a student who values it at $60 would never buy it. Additionally, even though the course is digital, meaning it could cost the firm almost nothing to supply another copy, the transaction would fail to place, resulting in deadweight loss. This is when mutually beneficial transactions fail to take place, because the price is too high for the consumer.
However, it isn’t entirely selfish. Price discrimination can allow for some consumers to gain access to goods or services they might not be able to get access to at one fixed price. This leads to a win-win that expands the market.
Finally, is this fair? This depends entirely on where you stand. If you are the distressed business traveller paying $800 for a last minute ticket, it definitely doesn’t seem fair to you. On the other hand, if you are a prepared vacationer who paid $150 for the same flight because you booked your tickets earlier, you have benefitted from the system.
Ultimately, price discrimination is just a reflection of human behaviour, we value things differently depending on who we are, where we are, and how badly we need them. Businesses are simply keeping score.