Businesses often price discriminate, charging different customers different prices for the same good. It is usually the case that the customer who pays the higher price is subsidizing the customer who pays the lower price. One pays \($100\) for the good so that the other can only pay \($80.
Hear\) what and how the economist thinks:
Think about this for a minute. From what this person has said, it sounds as if he believes that the person who pays \($80\) for the good is provided some sort of deal or discount because there is a person who pays \($100\) for the good. It’s as if the seller thinks, “I can charge a high price (\($100)
to\) the first person, which means I can charge a lower price (\($80)\) to the second person, so I might as well go ahead and do this, because all I really want to earn from the two buyers is \($180.”
Now\) why would the seller choose to sell the good at a lower price (\($80)\) just because he or she charged a higher price (\($100)
to\) someone else? Wouldn’t it be better for the seller to charge the highest price it could to each and every customer—assuming that it could price discriminate? To illustrate, suppose there are two individuals, A and B, and the highest price that A can be charged and still buy the good is \($100,\) and the highest price that B can be charged and still buy the good is \($99.\) Wouldn’t the seller be better off charging A \($100\) and charging B \($99\) instead of charging A \($100\) and B \($80?\) In short, wouldn’t the seller be better off charging each customer the highest price he or she would be willing to pay instead of charging one person a higher price so that he can then charge another person a lower price?
The mistake that this person makes in thinking that one person pays \($100\) so that another can pay \($80,\) is that he or she sees two prices, one higher than the other, and jumps to the conclusion that the person who pays the higher price somehow makes it possible for the seller to then charge a lower price to someone else. This leads to the reasoning that, somehow, the person who pays the higher price is “subsidizing”
the person who pays the lower price.
But this story line doesn’t make sense if we hold that sellers would want to earn as much total revenue as possible, all other things being the same. Yes, \($80\) is a lower price than \($100,\) but still, it is likely that each of the two prices is the highest price that different buyers are willing and able to pay. The seller isn’t saying: “Now that I have charged one buyer \($100,\) I can now charge \($80\) to another buyer, even though that other buyer is willing and able to pay \($99.”\) Instead the seller is asking himself why he or she should give up the difference between \($99\) and \($80\) if there is no need to. Why leave the \($19\) difference for someone else if there is no need to?
Now think of the following. Suppose Smith owns a car dealership.
Two people come in to the dealership to buy the same make and style of car. One person Smith does not know. The other person has been a lifelong friend of Smith. Let’s suppose the highest price that each person is willing and able to pay for the car is \($40,000.
Smith\) ends up selling the car to the person he doesn’t know for \($39,500,\) and he ends up selling the car to his lifelong friend for \($38,000,\) even though he is quite sure that the his lifelong friend was willing and able to pay \($39,500.\) Is this a case where one customer pays more so that the other customer can pay less? The answer is still no. What we have here is Smith, the owner of the car dealership, giving his lifelong friend a gift, of sorts. Smith knows that his friend will pay \($39,500\) for the car, and that he will be giving up \($1,500\) in revenue if he sells the car to his friend for \($38,000,\) but he is still willing to give this \($1,500\) gift to his friend.
Questions:
1. An adult and a child go to see the same movie in a theater. The theater charges the child \($6\) to see the movie and it charges the adult \($12\) to see the movie. Is it the case that the adult is paying a higher price so that the child can pay a lower price? Explain your answer.
2. A person aged 30 and a person aged 70 both order the same entrée at a restaurant. The younger person ends up paying full price for the entrée and the older person receives a 10 percent discount because he is a senior citizen. Is the younger person paying more so that the older person can pay less?