New Directions for Price Discrimination: Theory and Evidence

Paper Session

Friday, Jan. 6, 2017 10:15 AM – 12:15 PM

Swissotel Chicago, Zurich C
Hosted By: American Economic Association
  • Chair: Dirk Bergemann, Yale University

Surge Pricing Solves the Wild Goose Chase

Juan Camilo Castillo
,
Stanford University
E. Glen Weyl
,
Microsoft Research and Yale University

Abstract

Why is dynamic pricing more prevalent in ride-hailing apps than movies and restaurants? Arnott (1996) observed that an over-burdened taxi dispatch system may be forced to send cars on a wild goose chase to pick up distant customers when few taxis are free. These chases occupy taxis and reduce earnings, effectively removing cars from the road and exacerbating the problem. While Arnott dismissed this outcome as a Pareto-dominated equilibrium, we show that when prices are too low relative to demand it is the unique equilibrium of a system that uses a first-dispatch protocol (as many ride-hailing services have committed to). This effect dominates more traditional price theoretic considerations and implies that welfare, profits and rides cleared fall dramatically as price falls below a certain threshold and then decline only gradually in price above their maxima, which are tightly clustered. A platform forced to charge uniform prices over time will therefore have to set very high prices to avoid catastrophic chases. Dynamic “surge pricing” can avoid these high prices while maintaining system functioning when demand is high. We show that pooling can complicate and exacerbate these problems and consider alternative engineering solutions.

The Limits of Price Discrimination With Non-Linear Demand

Dirk Bergemann
,
Yale University
Benjamin Brooks
,
University of Chicago
Stephen Morris
,
Princeton University

Abstract

We characterize possible welfare consequences of a monopolist having additional information about consumers' tastes, beyond the prior distribution. The additional information can be used to charge different prices to different segments of the market, i.e., carry out "third degree price discrimination". Bergemann, Brooks and Morris (2015) gave a characterization of possible welfare outcomes if consumers had single unit (or linear) demand for the good. It is possible to attain any combination of consumer and producer surplus such that: (i) consumer surplus is non-negative, (ii) producer surplus is at least as high as profits under the uniform monopoly price, and (iii) total surplus does not exceed the surplus generated by efficient trade. Here we characterize possible welfare outcomes when there is non-linear demand for quantity or quality. This problem thus corresponds to a combination of second and third degree price discrimination.

Nonlinear Pricing in Village Economies

Orazio Attanasio
,
University College London
Elena Pastorino
,
University of Minnesota

Abstract

We propose a model of price discrimination to account for the nonlinearity of unit prices of basic food items in developing countries. We allow consumers to differ in their marginal willingness and absolute ability to pay for a good, incorporate consumers' subsistence constraints, and model consumers' outside options from purchasing a good, such as self-production or access to other markets, which depend on consumers' preferences and income. We obtain a simple characterization of equilibrium nonlinear pricing and show that nonlinear pricing leads to higher levels of consumption and lower marginal prices than those implied by the standard nonlinear pricing model. The model is nonparametrically and semiparametrically identified under common assumptions. We derive nonparametric and semiparametric estimators of the model's primitives, which can easily be implemented using individual-level data commonly available for beneficiaries of conditional cash transfer programs in developing countries. The model well accounts for our data on rural Mexican villages. Importantly, the standard nonlinear pricing model, a special case of our model, is almost always rejected. We find that sellers have large degrees of market power and exert it by price discriminating across consumers through distortionary quantity discounts. Contrary to the prediction of the standard model, consumption distortions are less pronounced for individuals purchasing small quantities, despite the steep decline of observed unit prices with quantity. Overall, most consumers tend to benefit from nonlinear pricing relative to linear pricing. A novel result is that when sellers have market power, policies such as cash transfers that affect households' ability to pay can effectively strengthen sellers' incentive to price discriminate and thereby give rise to asymmetric price changes for low and high quantities, which exacerbate the consumption distortions associated with nonlinear pricing. We find evidence of these patterns in response to transfers in our data.

Zone Pricing in Retail Oligopoly

Kevin R. Williams
,
Yale University

Abstract

We quantify the extent to which zone pricing, or setting common prices across distinct markets, softens competition in the retail home improvement industry. While monopolists can only increase profits by price discriminating, this need not be true when firms face competition. With novel data for retail drywall, we find industry profits increase when firms commit to coarser pricing. However, the results are asymmetric across firms: Home Depot would benefit from finer pricing but Lowe's would prefer coarser pricing. Finer pricing decreases consumer surplus overall, but only modestly as a commitment to not price discriminate protects consumers in markets where firms have substantial market power.
Discussant(s)
Christopher Snyder
,
Dartmouth College
Chris Nosko
,
University of Chicago
David Atkin
,
Massachusetts Institute of Technology
JEL Classifications
  • D4 - Market Structure, Pricing, and Design
  • D8 - Information, Knowledge, and Uncertainty