Bazaar Pricing

Followup to: Price Caps For someone running a rug shop in a Turkish bazaar, knowing the maximum price each customer is willing and able to pay for a given item would be a boon to his business. Since haggling is the hallmark of a bazaar, he could easily engage customers individually and use this knowledge to extract every last  kuruş from the consumer surplus and maximize his profits. Economists call this perfect price discrimination.

A skilled haggler can still do well without this perfect knowledge, however. Price discrimination--charging a different price to customers for the same thing--relies on the ability of the seller to separate the market and deal with customers individually.  Physical separation is endemic to a bazaar, but not so in Western retail, where most things come with set prices.  Western firms have therefore devised a multiplicity of methods to reap the benefits of price discrimination within a different market structure that does not see much individual interaction.

One ubiquitous method is through a sort of Dutch auction. Sellers introduce goods at a high price, and then lower the price over time in order to draw more people in the market (usually this is done through sales or specials). In this way, the customers reveal their personal demand--and are separated--by when they choose to make the purchase.  Apple did this very thing with the iPhone, which had its price cut $200 several weeks after its launch (much to the chagrin of early adopters, who presumably would hate shopping in a bazaar).

Sellers can also separate the market by making certain items hard to obtain or by making them eligible only to certain customers. Tim Harford, for instance, claims that Starbucks has an unlisted smaller-size cappuccino, which one can only get if it is asked for by name. This ensures that only price-sensitive and cocksure customers will go for the smaller size, while most everyone else will take the larger, more expensive brew.  Fast food places offer "kid's' meals" and discourage adults from eating them. Store loyalty cards (think grocery stores) aren't so much about loyalty as they are about being able to charge a higher price to people too indifferent to apply for a discount.

Branding also allows for discrimination. Put a different logo on otherwise identical sweaters and one can command a higher price for one over the other, even if sold side by side. Sellers also separate in more creative ways, such as was highlighted on the Freakonomics blog:

Price discrimination may always seem devious, but it does tend to benefit--aptly enough--the more discriminating among us; airlines and iTunes make good examples. On my recent flight to Pennsylvania, I had to pay $15 dollars to check a bag. Some people grumble about this, but they do so under a strange assumption that this expense is new. But what's new isn't the expense, it's the fact that the expense can be avoided--I might forgo even the peanuts pretzels if it would lower my ticket price! Similarly with iTunes, I no longer have to buy a bundle of songs in the form of a CD, but can pick and choose only the songs I like at a lower cost.

And did I mention the fact that my hair has never looked better?