Saturday, December 3, 2011

Laurence M. Vance: Price discrimination is fair and just

  While on a recent cross-country flight, I looked around at the 200 or so other passengers on the plane and thought, not about the snacks we would be served (pretzels), the movie we would be shown (Rise of the Planet of the Apes), or whether the babies on the flight would cry the whole way (they did), but about economics and economic justice.

  I wondered about the truth of the oft-repeated claim that no one on an airline flight pays the same amount for his ticket as anyone else and the question that is sometimes raised whether that practice is fair.

  Airlines engage in a form of what is known as price discrimination. It is typically defined as selling the same product to different people for different prices on the basis of their willingness to pay and not for reasons associated with product costs.

  This should not be confused with the price discrimination outlawed by antitrust legislation such as the Robinson-Patman Act of 1936 amendments to the Clayton Act of 1914. There the government attempted to protect small independent retailers and their independent suppliers from what was thought to be unfair competition from vertically integrated, multi-location chain stores. It was designed, according to the FTC and the Supreme Court, “to assure, to the extent reasonably practicable, that businessmen at the same functional level would stand on equal competitive footing so far as price is concerned. ” But regardless, antitrust legislation is central planning and is therefore inimical to liberty and the free market, as I have shown here.

  Other non-examples are higher rates for life and auto insurance for males, and special discounts for employees or military personnel.

  In order for real price discrimination to work, buyers must have differing abilities and the willingness to pay different prices for goods and services, and sellers must be able to recognize that and capitalize on it.

  This is sometimes expressed by economists by the concept of price elasticity of demand; that is, the responsiveness of consumers of the quantity demanded of a good or service to a change in price. The demand for a good or service is inelastic when a change in price has a negligible effect on the quantity demanded; the demand for a good or service is elastic when a change in price has a significant effect on the quantity demanded. In order to charge a higher price to the group with a more inelastic demand and a lower price to the group with a more elastic demand, sellers must be able to prevent a consumer from the elastic group from purchasing a good or service at a low price and reselling it to a consumer from the inelastic group who is willing to pay a higher price.

  In the case of airlines, they charge lower prices for consumers with elastic demand (generally pleasure travelers) and higher prices for consumers with inelastic demand (generally business travelers). One way they do it is by mandating advance-purchase or minimum-stay requirements that, in general, tourists can take advantage of and businessmen can’t. The whole arrangement is enforced by making the discounted tickets nontransferable and nonrefundable and the expensive tickets just the opposite. Moreover, airlines in many cases charge different prices within each group, depending on how far in advance the ticket is purchased, the day of the week the ticket is purchased, the time of day the ticket is purchased, whether the ticket is refundable, whether the ticket is upgradeable, and the location where the ticket is purchased.

  But is it true that no one on an airline flight pays the same amount as anyone else for his ticket? I think this has been overstated. There are plenty of reasons why the person sitting next to you on a flight may have paid a different amount.

  Aside from the pleasure/business travel distinction and the resulting difference in the nature of the tickets (and hence their price), there are other factors to be considered as well. Sitting in first class, with its wider seats, beverage and meal perks, and proximity to the front of the airplane, is obviously worth more to most flyers and therefore commands a higher ticket price. The same could be said of sitting in an exit row with its increased legroom. It could also be argued that sitting near a lavatory, on the aisle, or next to a window might be worth more to some people.

  But aside from those things, are all other seats of equal value? What many people forget is that since most airlines often fly multi-leg flights through a hub, such as Salt Lake City, Houston, or Atlanta, the person sitting next to you on a flight from Orlando to Los Angeles may in fact be going on to San Francisco (as I was) or to San Diego (as was the person next to me).

  But suppose it is true. Suppose that every single person on every single airline flight pays a different price for no apparent reason other than his ability and willingness to pay. How can that be fair?

  First all, price discrimination can actually be good for all parties. A columnist from Forbes, in an old, but still-relevant article, explains how that can be:

          Imagine that a ferryboat can be hired to cross a river at a cost of $200. Five customers are so eager to get across that they would pay up to $24 apiece. For another 15 the trip is worth only $8 max. What should the fare be? If it’s $8, revenues of $160 don’t cover the costs. At any higher fare, revenues will be at most $120. The boat can’t leave the dock. Now suppose there is some way to identify the prosperous five and get them to buy $22 tickets. Let the others board for $7. The passengers all pay less than the value of the journey to them; the ferryman makes a $15 profit. Everybody wins.

  But second, and more important, there is nothing fairer than an exchange between a willing buyer and a willing seller. The free market allows buyers (who want to acquire goods at the lowest price possible) and sellers (who want to sell their goods at the highest price possible) to come together in harmony.

  At a garage sale or flea market, the seller sets a price and then the buyer is expected to either pay the price or make an offer of a lower price. If a seller thinks he can get a price close to what he was originally asking from a particular buyer, he will continue haggling with him until he gets as much as he can; if not, the seller will either take less or stop negotiating. The fact that two identical items are sold at different prices to two different buyers is irrelevant. The fact that one buyer voluntarily pays a higher price to the same seller for an identical item is irrelevant.

  No seller is legally or morally obligated to sell identical goods or services to different purchasers for the same price at any time. Similarly, no purchaser is legally or morally obligated to purchase identical goods or services from any sellers at any time for the same price. Furthermore, no seller is legally or morally obligated to tell any purchaser that he would have sold him a particular good or service for less. And no purchaser is legally or morally obligated to tell any seller that he would have paid more for a particular good or service.

  People exchange goods in a market economy to their mutual advantage. Each party to an exchange values what he receives at least as much as what he exchanges for it. Both parties are of necessity better off after an exchange than they were before the exchange, or else they would never have made the exchange in the first place.

  Government interference in the market cannot make the market fairer or more competitive; it can only distort or disrupt the market. Attempts to regulate markets by governments always have unintended consequences that are often worse than the problems that regulations were meant to cure. And besides, it is not the business of government to regulate how people conduct business.

  About the author: Laurence M. Vance is a policy adviser to The Future of Freedom Foundation. He is the author of The Revolution That Wasn’t. Visit his website: Send him email.

  This article was published by The Future of Freedom Foundation.

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