Question

Price Discrimination and Hurdles

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Negative connotations are likely when you combine “discrimination” with most words (e.g., “racial discrimination”). But, is price discrimination bad? The hurdle method of price discrimination is one method price-discriminating firms use to separate those who are willing to pay a high price from those who are more price conscious. The hurdle method is the practice by which a seller offers a discount to all buyers who overcome some obstacle. Consider a rebate offer as a hurdle. For example, imagine a good with a price of $100, but if consumers mail the completed rebate form, a portion of the packaging, and the sales receipt, the seller will refund $20. In essence, buyers who use the rebate pay a lower price if they are willing to “jump the hurdle” that the rebate provides. The rebate allows the seller to offer a discounted price ($80) to buyers who are not willing to buy a product at the higher price. In doing this, sellers attempt to divide buyers by their reservation price, which is the highest price a particular buyer is willing to pay for a good. Buyers with higher reservation prices (those willing to pay a higher price) are less likely to jump the hurdle, so they pay the higher price ($100). In our example, the seller is dividing consumers into two segments: (i) those whose reservation price is above $100 (who will pay the full price) and (ii) those whose reservation price is between $80 and $99 (who will pay the lower price of $80). Other types of hurdles might require buyers to wait for a longer time period or accept the same good but of a different quality to buy at the lower price.

Of course, this is not a perfect hurdle—it doesn’t perfectly separate consumers by reservation price. There are some consumers with higher reservation prices who might jump the hurdle and fill out and mail the rebate form and other required materials. And some buyers with lower reservation prices might not be willing to jump the hurdle and do not buy the good.

So, Is Price Discrimination a Bad Thing?

Believe it or not, price discrimination does have benefits. In the end, sellers can sell more goods by using price discrimination than if they sell only at one price. The extra units sold create additional profits for the firm (assuming the goods are sold above the cost of production). In short, sellers can expand the market for their product by offering it at different prices to different consumers.

Buyers also benefit from price discrimination. Those with lower reservation prices would be excluded from buying the good if the rebate were not offered. In this case, some buyers whose reservation price is at least as high as the discounted price—and are willing to jump the hurdle—benefit from price discrimination. Of course, some buyers with high reservation prices might pay more than if the firm had not chosen to price discriminate. If the seller were to pick one price rather than two, the single price would probably be lower than the highest price under price discrimination. In our scenario, instead of price points at $100 and $80, perhaps the single price would have been $95.

Choose one of the following common marketing tactics and discuss how it can be used as a hurdle:

• Special sales offering discounted prices from 4 a.m. to 6 a.m.
• Books released as hardcover copies for $40 when first published and then as paperbacks for $8 one year later
• Movie openings in premium theaters, then discounted theaters, then DVD release
• Commercial airlines with restricted supersaver airfares

Include in your discussion specific information on why the hurdle would most likely not be challenged by the government as an illegal form of antitrust behavior.

Answer 1

Let's discuss the third one, i.e., move openings in premium theatres, then discounted theatres and then DVD release

If a studio anticipates a movie to be very popular even before its release it may use the above mentioned tactic. We call it price discrimination in economics and skimming in marketing. The studio will first try to extract the highest price the most sophisticated (or rich) movie-goers are willing to pay by releasing the movie in premium theatres only. The ticket prices in such theatres would be higher than in a normal theatre, and there would be extra amenities, e.g., better seats, free refreshments, etc. Movie-goers would not mind paying extra for a move they really want to watch and would justify the price to themselves using the extra amenities, as well as the privilege of watching the movie before 'general' movie-goes who would watch it when it releases in a regular theatre. Once a reasonable duration of time has elapsed (or the studio believes it has exploited enough number of premium sales), the movie would be released in regular theatres and then made available on DVD. This would allow the studio to recover differential price from each type of movie-goer, a good example of price discrimination.

The fact that extra amenities are being provided in the premium theatres, and these things cost even if not as much as the difference between the ticket price in a premium theatre and a regular theatre, would be used by the studio when challenged by the anti-trust agencies.