Yesterday before class a student came to my office hours to ask a few questions about Chapter 12 of Cowen and Tabarrok, “Price Discrimination.” I said to her, “There’s a lot of interesting stuff in this chapter.” She replied, “Yes, a LOT of interesting stuff.”
While most introductory textbooks make the determination of prices a rather cut-and-dried, mathematical proposition, C & T explain the creativity that goes into the determination of prices — the immense amount of ingenuity on the part of sellers to figure out just the right price for each market and how to tweak pricing policy in order to grasp fleeting profits. Telling examples include arbitragers smuggling life-saving drugs back into their country of origin, airlines trying to deduce who will pay more, price differences between hardcover and paperback books, IBM slowing down one of its laser printers, the mystery of why ink cartridges are so expensive while printers are so cheap, why Microsoft bundles its software, cable TV pricing … the list goes on. The chapter offers up one insight after another, demonstrating the power of applying just a little economic theory in the right way. The chapter has only 3 graphs and two of them are essentially the same as a graph already explained in the previous chapter– the point being that the avalanche of insightful examples is what makes this chapter work.
At the end of class, I actually (briefly) broke out in song. (Several students had very skeptical looks on their faces — what is this guy pulling?). I watched The Wizard of Oz with my wife on Saturday night and explained to the class that I felt just like the Scarecrow — with useful economic theories like these, “I’d unravel every riddle for every individdle in trouble or in pain …”
However, I do think C & T went overboard in their example about price discrimination and Williams College. Their premise is that Williams — just like American Airlines, Hewlett Packard, or GlaxoSmithKline — aims to maximize profits. Since I teach at a private liberal arts college, we discussed this issue for about 5 minutes in class. Williams/WFU don’t have shareholders who get to claim their share of profits, so modeling them as profit-maximizers is iffy. What are private colleges trying to maximize, if not profits? My bet is that they are trying to maximize something akin to “prestige” — which is often fuzzy and oftener quite a bit different than maximizing profits. A college like mine has many more apllicants than spaces available, so it turns away a lot of people willing to pay list price while accepting many who pay far less and simultaneously refusing to expand output significantly. It’s hard to square this with profit maximization. How would the University of Phoenix behave in this circumstance?