I missed this story when it was first reported, but Hamilton Gardens has made the decision to introduce a $10 entry fee once their new entry precinct opens at the end of the year. However, entry for Hamilton residents will remain free. As Stuff reported:
The days of free entry to Hamilton Gardens are numbered for visitors from out of town as work begins on a new precinct at the flagship attraction.
Tourists will pay $10 for entry to the themed gardens when the entry precinct is complete, possibly by the end of the year, while Hamilton residents and children under 16 will get in for free.
Work is set to start next month on the area, which is also intended to better open up the Gardens for visitors, making it easier to see what is on offer.
This is a great idea, and backed by solid economics. I've made the point before that, if tourist operators are trying to maximise profits, then tourists should be paying more for tourist activities than locals (see here, and here, and here). To see why, let's look at the example of Hamilton Gardens. As the Stuff article notes:
Hamilton & Waikato Tourism chief executive Nicola Greenwell said the Gardens are one of the region’s top offerings.
“They're incredibly important to our visitor offering, they are one of our hero products. So they do attract a large number of people to our city and to our region.”
She thinks visitors will take the $10 fee in their stride. “I think that the offering that the Hamilton Gardens has is world-class, and it is well worth an entry fee.”
Tourists will take the $10 fee in their stride, but not just because of the world-class nature of the gardens. We'll get to that a bit later. First, some theory.
Price discrimination occurs when a firm sells the same product to different customers for different prices, and where the difference in price doesn't arise from a difference in costs. In this case, access to Hamilton Gardens will be free for Hamilton residents, but cost $10 for tourists. That difference in price does not result from a difference in costs, because it costs Hamilton Gardens the same to host a visitor regardless of where the visitor is from.
For price discrimination to work, three conditions have to be met:
- Different groups of customers (a group could be made up of one individual) who have different price elasticities of demand (different sensitivity to price changes);
- The seller needs to be able to deduce which customers belong to which groups (so that they get charged the correct price); and
- No transfers between the groups of customers (since the seller doesn't want the low-price group re-selling to the high-price group).
In the case of Hamilton Gardens, there are two groups of visitors (locals and tourists). Why does the price elasticity of demand differ between these two groups? Tourists have lower sensitivity to price (low price elasticity of demand) for a couple of reasons. First, for visitors there are few substitutes for visiting Hamilton Gardens (or other tourist attractions). Locals have lots of alternative activities (like staying at home watching Netflix). When there are fewer substitutes, the price elasticity of demand is lower. Second, tourists have usually also travelled further than locals, at higher cost, in order to get to Hamilton in the first place. So, the cost of entry into Hamilton Gardens is pretty small in the overall cost of their holiday. Whereas for locals, the cost of entry into Hamilton Gardens (if there was an entry fee) is essentially the entire cost of their visit. When the price is a smaller component of the total cost (as it is for tourists visiting Hamilton Gardens), the price elasticity of demand is lower. For both of these, tourists will be relatively insensitive to price compared with locals, and raising the price of entry for tourists isn't going to keep them away in great numbers.
That covers the first condition for price discrimination. For the second condition, Hamilton Gardens needs to be able to tell who the Hamilton residents are (because they get free entry) and who the tourists are. And for the third condition, Hamilton Gardens needs to ensure that Hamilton residents can't 'buy' free tickets, and then give them away to tourists (as that would defeat the entire purpose of price discrimination). Let's assume that Hamilton Gardens has a good way of doing these things (and we'll come back to that later).
Since those conditions are met, Hamilton Gardens can price discriminate. This is shown in the diagrams below. Both diagrams show a firm with market power (Hamilton Gardens), and each diagram corresponds to one of the sub-markets. The sub-market on the left represents the locals, who have more elastic demand - notice that the demand curve D1 is relatively flat (which means that a change in price will have a big effect on the quantity that these consumers demand). The sub-market on the right represents the tourists, who have less elastic demand - notice that the demand curve D2 is relatively steep (which means that the same change in price would have a smaller effect on the quantity that these consumers demand, than it would for the locals). The marginal cost (MC) is the same in both sub-markets - as noted earlier, it doesn't cost Hamilton Gardens any more to provide entry to a local than it does for a tourist. [*]
Hamilton Gardens will maximise profits by selling the quantity where marginal revenue (MR) is equal to marginal cost (MC) - this is the standard short-run profit-maximising condition. In the tourists sub-market, the profit-maximising quantity occurs where MR2=MC, which is Q2. In order to sell that quantity in the tourists sub-market, Hamilton Gardens should set the price equal to P2. The problem with that high price P2 is that in the locals sub-market, no consumers would be willing to visit Hamilton Gardens at all. Hamilton Gardens can increase profits if it charges a different price in the locals sub-market, from the price it charges in the tourists sub-market. In the locals sub-market, the profit-maximising quantity occurs where MR1=MC, which is Q1. To sell that quantity in the locals sub-market, Hamilton Gardens should set the price equal to P1.
So, profit maximising across both of these sub-markets would require Hamilton Gardens to sell to the locals sub-market at a low price (P1), which may be equal to zero, while at the same time selling the same entry to the tourists sub-market at a high price (P2).
Now, there are some problems with this approach. Hamilton Gardens needs to be able to tell Hamilton residents apart from tourists. There are limited practical ways to achieve this. Perhaps Hamilton City Council issues an ID card to every resident? That would be effective, but expensive. So, perhaps Hamilton Gardens simply asks residents to bring proof of residency with them to get free entry. That could be a rates bill, or an electricity bill, or similar, with their residential address on it. Hamilton Gardens could, in theory, then match the name on the bill with some other form of ID, to make sure that the person wanting free entry is the same person named on the proof of address. I doubt they would do this, because it will take a lot of time and effort, and because sometimes you live at an address, but the bills are not in your name.
So, it's likely that all that will be required is a utility or rates bill with a Hamilton address on it, to get free entry to Hamilton Gardens. That will mean that this attempt at price discrimination doesn't strictly meet the second condition for price discrimination - Hamilton Gardens won't effectively know who is a resident, because any Hamilton resident can give a proof of address to a tourist, which would allow the tourist free entry to Hamilton Gardens. None of that means that price discrimination will fail entirely here. Movie theatres don't check ID before allowing entry, and they seem to get away with price discrimination just fine [**].
*****
[*] Notice that we are drawing a constant-cost firm here (so marginal cost is equal to average cost, and all units cost the same to produce and sell). That makes our explanations a little easier than the case where marginal cost is increasing.
[**] As far as I know, no student has ever taken up the business opportunity I point out every year, to buy tickets for people who would otherwise pay general admission at movie theatres, and pocket (some of) the difference in prices.
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