Price Discrimination

I’ve been thinking about weird markets where the normal math of supply and demand doesn’t work. I discussed some of these in a comment on the Picasso post below (by the way, get over there and comment about the pictures!).

Another example is buying things over the Internet: both regular goods like books which Amazon.com and other online booksellers will provide cheaper for the right person (big example: college textbooks in the USA are enormously expensive but have “overseas editions” which are half the price or less, which can be obtained from private sellers whom Amazon.com facilitates your finding), and digital goods like music and software where the incentives to illegally copy must be dealt with.

I don’t understand, for example, why buying downloadable songs needs to be so expensive. It seems that there must be some price point at which the incentives to avoid lawbreaking overcome the small amount of money to be saved, and that such a point ought to result in both more profit for the publisher and less lawbreaking than the current system exhibits, but I don’t have data to back this up.

Here is a classic article on the issue, by the mathematician Andrew Odlyzko, which explains why “price discrimination” (making how much you pay for something depend on who you are) is not going to go away, and why it makes Internet privacy so much more expensive and difficult to come by.

Privacy, Economics, and Price Discrimination on the Internet

Economics students will enjoy Odlyzko’s related papers here.

What makes Price Discrimination such an interesting and vexed issue is that while it unquestionably leads to better allocation of resources than fixed pricing, it is extraordinarily unpopular with consumers and thus must be disguised or coerced through regulations which allows the producers to escape blame. There is a corresponding political incentive for producers to support such regulations. My college-age daughter ran into an example of this last week when buying a bus ticket to come home for her Thanksgiving break; an $18 fee, which was 35% of the original ticket price, was charged because the ticket was bought on the Internet with a credit card (mine) in the name of someone other than the traveler. They pretend this is for security reasons, but no verification of identity takes place, and it is always possible to buy a ticket anonymously by going to a bus terminal with cash. The bus company figured that when someone else is paying the traveler is less likely to protest.

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17 Responses to Price Discrimination

  1. rebelliousvanilla says:

    Since we’re at prices, I hope you did buy what I told you to buy. ACQ is up by 120% since I told you to get silver and the price of silver itself more than doubled. πŸ˜›

    What I would do as a politician is force retailers like Amazon from publishing their pricing for other markets. It’s transparency and consumer choice. I want to know if a company does it because I’d refuse to purchase anything from them. Actually, any smart person would do this.

  2. rebelliousvanilla says:

    To sum it up, information asymmetry is a problem in the economy. Since companies can collect data about us, I see it as normal that they should be forced to be transparent and share their pricing for different markets. πŸ™‚

  3. This is how I see it. There are some goods which obviously create different costs for different customers, such as health insurance, so price discrimination is OK there (even though that is the kind that gets the liberals all upset because it involves the d-word and would hurt members of politically preferred groups such as blacks and gays). But there are other goods which are commodities that can be transferred easily between consumers. For those goods, a price discrimination regime depends on legal restrictions on transfer. For example, airline tickets can be required to be sold to specific individuals and not transferred between individuals, a piece of legislation the airlines were perfectly happy with because it allowed them to price-discriminate. And prescription drugs cannot be freely sold, which is why drug companies can charge so much to pharmacies, and also why pharmacies can charge so much to individuals who have a prescription but no drug coverage in their health plan or no health plan.

    An example of an illegal business model I would not criticize is someone who buys prescription drugs from people who legally obtained them, and resells them to people who can’t legally obtain them as cheaply as the original people he bought them from.

    For commodity goods, this circumvention of legal restrictions would create more efficiency in one sense, but less in another sense. The problem is the difference between fixed and marginal costs. For new drugs, or computer software or books or music, the marginal cost of producing additional items can be small compared with the expenses involved in inventing or creating the product in the first place. Another example is network traffic, which you pay for on your phone bill or internet provider bill — you get charged to pay for the overall cost of the system, and it’s not very closely related to your specific usage which is hard to “cost out”.

    There needs to be a way for producers to recoup the fixed costs involved in creating and setting up production for a good which can be mass-produced as a commodity afterwards. This is a serious issue which I have not seen well-treated in economics textbooks. Price discrimination is an easy way to solve it, and if you take measures to commodify the good by allowing transfers between individuals to freely occur, you reduce the incentives to create new products in the first place. The other main method of addressing this problem is patents and copyrights, which restrict competition at the seller end rather than free transfer at the buyer end. I’d love to see a rigorous paper discussing the pros and cons of these two methods of addressing the fixed vs marginal costs problem.

    On the other hand, transparency is always good because it does not introduce a significant cost burden on the producer; however as RV points out the market can enforce this without regulation, customers should just demand it. The only role of the government here is to punish producers who lie while pretending to be transparent, which is a form of fraud.

  4. rebelliousvanilla says:

    I don’t see why consumers shouldn’t be allowed to exchange the goods that they acquired among themselves. If I buy a certain good, I don’t see why I shouldn’t be able to sell it to you. Let’s not forget that optimal allocation models are created on ideal markets(atomized consumers and producers, none with enough power to change the optimal price of a certain thing), which isn’t the case. Also, licensing, for example, wouldn’t exist in such a market. When a company applies for a patent, it is common sensical to me that the government who enforces that patent should require the company to offer the best deal to its citizens.

    Oh, and I don’t mind price discrimination where each individual has a different cost like in the situation of insurance, the real problem comes when you sell the same product at different prices.

  5. Polymath says:

    Of course I agree, but with prescription drugs they prohibit free resale supposedly out of concern for our safety, though really because the drug companies like it that way. (Exception for antibiotics, there there is a real public health problem related to promoting the evolution of resistant bacteria, so making sure they are only taken as prescribed is a good idea.)

    “The best deal for our citizens” is fine, though it raises some interesting issues with multinational corporations which might want to apply for a patent in more than one country.

  6. rebelliousvanilla says:

    Polymath, multinationals would be forced to treat the citizens of all countries that get patents equally as in offer the same prices.

  7. Polymath says:

    Here’s a relevant story:

    Copyright Enforcement Tail Wags Internet Dog

    The damage from a system where there is so much illegal copying is more than just economic — even more reason to figure out a better pricing scheme.

  8. rebelliousvanilla says:

    You mean the corruption of American politicians is the fault of people who do illegal copying? πŸ˜€

  9. Polymath says:

    I didn’t say that. I said that a system in which there is so much illegal copying is damaging — it creates incentives for corporations to pay off politicians to pass unconstitutional legislation.

    Someone like you, from a country with low per capita income but high prices, would obviously welcome price discrimination and have incentives to copy in its absence; the existence of easy copying commodifies the goods and makes price discrimination very difficult, so you get screwed (obviously you have no obligation to respect U.S. copyright law, but since you joined the EU recently you have to abide by theirs which reciprocates with the U.S.–another example of how the EU shouldn’t yoke together countries with such different economies).

    There is a real structural problem here, and I don’t have the answer, I’m just calling for suggestions for a better system. You have to figure out a way for software companies, in particular, to make a profit — I don’t care about writers and musicians so much, because tools are available for self-producing and self-publishing now and they don’t need to go through big companies, but lots of software still requires corporate investment (another example where big investment needed is movies, although that problem is not so bad yet because they are so huge that illegally copying them over a network is more difficult).

  10. Polymath, in the end, corporations need to choose. Still, I think their business model is completely idiotic. They should use the information of the consumers they have to offer them value added when they buy the genuine products. The problem is that they don’t want to do anything, but cash in checks. And I don’t see why as an American, I should put up with the same thing being sold to Romanians cheaper, just because Microsoft wants to sell copies there too. The US government should do what’s in the best interest of Americans, not in the best interest of Microsoft. Obviously, I’m a fan of this because it would also hinder the idiotic technology transfers from us to third worlders.

    You can look at the gaming industry for the most cynical idiocy. They make console games and then they do a crappy job at making them compatible on PC and sell them like that. And when their sales are rubbish, they blame piracy. GTA4 was a brilliant example of this. For PC, you had to log in on countless programs, the game wasn’t efficiently done for running on a computer and so on(it had ridiculous spec requirements for what it offered and so on). Why would anyone pay $50 for that? What was absolutely hilarious is that the cracked version removed the log in requirements, which made the illegal version better since you had less hassle to put up with. The whole industry needs to offer something more than the game or software itself.

    For music, you have a lot of customized things for fans, for PC games you have all types of online activities, for Windows, they could actually make them properly. They could also stop including all types of useless applications in it and they should allow you to buy them separately if you want to use them and so on.

    Oh, and what’s the most pathetic about software companies is that they’re making a profit, but talking about how high prices are the faults of people who are into piracy. They talk like they would drop prices and decrease their profit margins if everyone bought their stuff at the high prices. LOL. And corporations will always pay off politicians to pass legislation that favors them. It’s just like politicians will always be money grabbing liars.

  11. Polymath says:

    I agree with all this, I just wish I could think of a better model. I suppose whoever does think of one will get very rich. The only thing that comes to mind is personalized watermarking — you buy something with authentic personal identification and then they create a unique version for you which allows any copy, even a copy where the information has been transformed in all sorts of ways, to be traced to you. Computer retailers would get a kickback from the software company for checking the contents of the computer when servicing it for pirated versions. The original owner would be able to notify the software company of the ID of a new owner if he sold his computer with its software, or gave the software as a gift, but then he would no longer be authorized.

    If they were really sneaky they could, when watermarking it, include some test questions you give them or a fingerprint scan digest (that is, something that would allow the fingerprint to be recognized but not reconstructed). This is not necessarily going to lead to big privacy violations, your ID can be anonymized through a trusted clearinghouse so that the software company doesn’t really know who you are, just whether you are the same person who bought the software or legally received it.

    BTW, thanks for keeping the blog going, today and yesterday nobody else commented, which is remarkable since 2 of the previous 3 days had set records. I hope the lurkers who are enjoying the Poly & Vanilla show will start contributing again.

  12. Polymath says:

    Here’s another relevant story:

    Prosecutors Dismiss Xbox-Modding Case Mid-Trial

    Although the case was dismissed, it’s not because the law was ruled unconstitutional, it’s because of a prosecutorial blunder (related to the government’s main witness conveniently remembering new damaging information that was not disclosed to the defense). It’s still illegal to modify a device so that it can play pirated games.

    This law raises the same constitutional questions as laws prohibiting cars from having radar detectors or prohibiting people from constructing their own signal unscramblers for broadcast TV. If someone is going to beam electromagnetic signals into my house or car, why shouldn’t I be able to analyze and parse them? And if I have bought a physical device and own it, why shouldn’t I be able to tinker with it to make it function more flexibly? These are restrictions on private behavior that is performed by someone working on and with his own property; even if a state could restrict such activity, the federal government shouldn’t be able to, though judges will probably stretch the “interstate commerce” clause to cover it.

    I was guilty of a copyright violation on this blog today. Did you notice?

  13. Gorbachev says:

    RV,

    “When a company applies for a patent, it is common sensical to me that the government who enforces that patent should require the company to offer the best deal to its citizens.”

    This mitigates the purpose of having a patent in the first place. It disincentivizes innovation. The whole idea is to create/establish a market and gouge it as much as possible until the patent runs out.

    Basically, patent law is a license to be a bastard in exchange for being creative.

    It’s hugely crucial to keep that incentive.

  14. Polymath says:

    RV meant that a U.S. Patent should have as a condition that the company give U.S. Citizens as good or better a deal than foreigners get, not that they should give them the best deal possible.

  15. Polymath, in my country it is legal to make your Xbox be able to play pirated games, but if you have pirated games, that’s a crime. It is legal to crack your own bought software and run it like that, for example. So if I buy a video game, I can crack it so that I don’t need to have the DVD in. And radar detectors are legal. The TV unscramblers though are illegal. And how should I notice copyright violations? My life is as copyrights don’t exist. πŸ™‚

    Gorbachev, I would keep that. You’d be able to be a bastard if you invent something, it’s just that you’d have to be as big of a bastard to everyone in the world.

  16. Polymath says:

    The copyright violation was putting the .PDF file of that science article on my site and giving a link to it, because although the journal makes it available if you have a university account or go to a good library, if you go there from a random Internet IP you have to pay for access. This is Nobel-quality science and nobody in the scientific world really cares about copyright (patents are a whole different matter lol). When I publish a math paper the journal won’t want me to make the exact article as it appears in their journal available, but it’s fine with them if I put a “preprint” online which is essentially the same (it won’t have the reformatting and editing the journal added).

  17. Gorbachev says:

    @RV,

    The joy of owning the patent is that you can charge a lower price to anyone you like; you can decide which markets pay more. It’s part of the economic freedom thing. You’re free to do what you want. Which means, unlike in a National Socialist regime, or any socialist regime, the government that gives you the patent can’t then turn around and tell you how to sell it.

    Again, that would be interference and disincentivizing innovation.

    So the drug companies overcharge Americans and Germans and undercharge Indians. They charge what the markets can bear. As much as they can.

    It’s not fair – but it’s definitely incentivizing innovation.

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