Shrink-wrapped books and price discrimination

One of the things I tell my ECONS101 class is that, once you know what to look for, you start to see price discrimination everywhere. Price discrimination is where a firm charges different prices to different customers for the same good or service (and where the differences in price do not relate to differences in the cost of providing the good or service).

Last July, Tyler Cowen had an excellent example on the Marginal Revolution blog, of why books are kept shrink-wrapped in Mexican bookstores:

Imagine there are two classes of readers.  The first is poorer, and only buys books when he or she knows the book is truly desired.  Harry Potter might be an example of such a book.   You want to read what everyone else is reading, to talk about it at school, and you don’t need to scrutinize p.78 so closely before deciding to purchase.

The second class of buyer is wealthier and usually will be buying (and reading) more books, indeed for those people book-buying is a significant habit.  That buyer wants to be on top of current trends, wants to have read whichever book is “best” that year amongst the trendy set, and so on.  If book quality is uncertain, such individuals will end up paying a de facto, quality-adjusted higher per unit price per book.  If you can’t sample the books in advance, you will end up buying some lemons, and you can’t just pick out the cherries.

For price discrimination to occur, you typically need to meet three conditions:

1. Groups of customers that have different price elasticities of demand (heterogeneous demand);
2. Different groups of customers can be identified; and
3. No transfers across submarkets.

In the case of shrink-wrapped books, Cowen has given the example of two groups of readers. Do they have different price elasticities of demand? If the first group is poorer, then the price of a book will take up a higher proportion of their income (as noted in yesterday's post, that is one of the determinants of the price elasticity of demand). That would tend to make their demand more price elastic (they are more sensitive to price). If the second group is wealthier, the price of a book takes up a smaller proportion of their income, and their demand is less elastic. So, it seems that this meets the first condition for price discrimination.

What about the second condition? In this case, buyers sort themselves into groups, and that means that the bookseller can tell them apart. The first group (poorer, more elastic demand) only buy the books that are popular and well known. The bookseller knows that those books attract customers with more elastic demand (more price-sensitive), and they set the mark-up (and price) on those books lower. The second group (wealthier, less elastic demand) buy all types of books. The bookseller knows to set the mark-up (and price) higher for all of the books that are not popular and well known. The bookseller is essentially offering different options at different mark-ups (and prices), knowing that some options appeal to more price-sensitive customers, while others appeal to less price-sensitive customers. This is an example of what we call menu pricing (or second-degree price discrimination).

For the third condition, there is no point in someone paying the low price on-selling to someone paying the high price, since the wealthier consumers can already buy the popular and well-known books at the same low price.

As Cowen noted, this is likely to be an example of price discrimination. Once you know what to look for, you see it all around you.