It’s not what you think. I’m talking about the “high-type” person in economic models of price discrimination. Sorry, but the rest of this post might help you make better cost-saving decisions in the future.
Let’s talk about discrimination
Recently, my fiancé became a victim of blatant price discrimination by the car rental agency.
She was angry. But, of course, like most crises, this is an excellent opportunity to bring up some economics.
She reserved her car online, at a base price that seemed reasonable. However, there was the fine print of “fees may apply” when she confirmed the reservation. Keep in mind; she wasn’t going to be charged until she came in person to select her car and finalize the rental.
When she showed up to the car rental agency, she was surprised with a bunch of mandatory add-ons to the base price. Because she is under 25, she was charged an extra fee. Also, because she doesn’t own a car, she was required to get the car rental insurance coverage. Plus, there were other “fees” which the airport charges the car rental agency and thus passed on to her. In the end, she paid double the base price she had reserved the car at initially.
The economics of it…
The goal of the car rental agency, or any seller of a good or service, is to get the highest price they can from consumers. One way they can do it is by simply charging a high price for their product. Unfortunately, they would lose out on a bunch of buyers who would be willing to pay for the product, but at a lower price. That’s not all that profitable.
So, sellers often engage in price discrimination. By finding ways to charge different prices to different people, sellers can make more profit.
What the car rental agency engaged in was a form of “second-degree price discrimination.” This type of discrimination occurs when the seller can’t tell the difference between the kinds of consumers buying the product. So, by charging different prices for the product at say different quantities or times, consumers will show how much they value the product to the seller and pay the higher (or lower) price options.
Think of matinee prices at the movie theater. By charging different rates at different times, the movie theater (the seller) can differentiate between different types of moviegoers, namely unemployed old folks and young workers, without actually trying to figure it out themselves. The buyers separate themselves by going at the different times.
Enter “high-types” and “low-types” consumers
The high-type consumer, like my fiancé, is in a position in which they will pay the higher price for the add-ons. High-types have a low marginal utility of income, meaning— the increase in price won’t hurt them too badly in the grand scheme of things, while the low-types, will be profoundly affected by the price change. Though my fiancé is still a few years from rolling in the doe, wealthy people are more likely to be a high-type consumer, because $200 to them, won’t break the bank.
In the behavioral world, high-types are also considered “unsophisticated” consumers, while, ironically, low-types are “sophisticated.” Unsophisticated consumers pay the high price because they stink at comparison shopping and/or are unaware of price discrimination! I’m here to rescue you.
Had she been a low-type consumer, she would have given herself time and researched the fees different car rental agencies charge for their add-ons. She also would be careful with her money, budgeting and accounting for every dollar she would put toward the rental car. In the end, she would not have been surprised by the sudden drastic price change.
Even though she was angry, she was still the high-type consumer. She agreed to pay for the add-ons.
Why don’t competitors list everything out?
Short answer: It isn’t profit maximizing. Everyone loses out.
But here’s how it would work: At first, car rental store B can decide to be fully transparent with their prices. At plain sight, the price of B is higher than the price of A. But, they can run a big ad campaign with “We aren’t swindlers over here! Everything is included with this price! Don’t be surprised at the checkout!” on a bunch of billboards.
If this advertising campaign brings in a bunch of customers, B makes a large profit. Seeing B make all these profits because they decided to include all the add-ons into one fully transparent price, “A” decides to do the same thing. When this happens, both sellers now have one, transparent price they charge equally to all consumers. Now, the only way to compete is by cutting prices, making both sellers lose out on the profits they could be making under a price discriminating setup.
Though B attempted to undercut the competition by being fully transparent with their prices, the high profits motivated all the other agencies to be transparent as well. Once all the agencies go to the “being transparent” system, sellers can’t profit off of the “high-type” consumers.
Inevitably, they go back to the price discrimination model, or some variation of it.
Moral of the Story
Well, in economics, morals do not really play a role. It just explains how things work. Price discrimination is everywhere. It’s more prevalent in industries with a few big businesses, or in areas where it’s a hassle to simply go to the competitor, like hotels, airlines, wireless services, theme parks, movie theaters, you name it.
If you’re a high-type consumer because you’re wealthy, then all the power to you. But, if you’re high-type because you’re unsophisticated, let this be a wake-up call. Don’t get discriminated against, because you’re high. Do your research, give yourself time to plan things out, and save a few bucks.