Arnold Kling  

Price Discrimination and Profitability

PRINT
Austrian Economics... Government and Research...

Alex Tabarrok asks,


If we graphed use of price discrimination against profits would we find a positive slope across the economy as a whole? I doubt it, yet this is what the theory would seem to predict. Send me your thoughts.

My first reaction is that it is difficult for me to come up with an in industry where there is not price discrimination, which means the attempt to charge higher prices to customers willing to pay them. For example, software pricing is all about price discrimination. Microsoft tries to charge less to educational institutions and to home users than it charges business users. Drug companies try to charge less to groups that can afford to pay less. I came away from reading Information Rules, by Carl Shapiro and Hal Varian, convinced that price discrimination is a key survival strategy in markets for information goods.

For Discussion. Tabarrok cites airlines and universities as examples of industries where price discrimination is rampant and profits are low. What explains the low profits in those industries?


Comments and Sharing


CATEGORIES: Microeconomics



COMMENTS (25 to date)
Eric Krieg writes:

Profits at universities are low?

Being that they are "non-profits", isn't that the whole point? They are not profit maiximizing institutions, so why would you expect them to make profits at all?

What about private schools like DeVry and Kaplan? They make some pretty goof profits (Kaplan makes most of the profit at the Washington Post).

John Thacker writes:

Airlines have a combination of strong competition, regulatory factors (getting approval for flights and runway usage in airports), and incredibly strong unions (esp. the pilots' union) that are able to capture a large portion of the profits.

Lawrance George Lux writes:

Airlines and Universities are self-evident, projecting they use Price discrimination but without high Profits. The answer is they are extremely profitable, but in an alternate context of portability. Both are Labor-intensive industries with rapidly expanding labor assets. The airlines use a huge Labor pool--above industry average per dollar of capitalization--to meet Safety requirements and reassure Customers by high Flight attendent complements. Universities continue to expand their administrative personnel at amazing rates and Payscales, because of lack of Ownership opposition; it is an industry run for the benefit of Labor. Both areas are economic areas of Labor ascendance.

I personally think Labor should have greater Voice and position in the rest of industry, but Labor's Voice in the two areas mentioned is far too loud. lgl

Dave Sheridan writes:

The economics of traditional colleges and universities are strange enough to merit completely separate treatment. However, some major and obvious price discriminators have in common that (for a single producer) only a finite number of product units are available at any given time. Consider airlines (flights to Cleveland at 9 AM), and hotels (rooms during the first week of June), These industries also have high fixed costs, and demand is subject to a high degree of fluctuation.

Lack of profitability may have more to do with poor long-term capacity planning than with price discrimination per se. So in response to Alex Tabarrok's question, these two industries may support rather than disprove the point. Hotels and airlines only have monopoly power in the very short term. They cannot limit supply in the longer term.

Bernard Yomtov writes:

Not sure I agree that universities that practice price discrimination are "low--profit" organizations, for a couple of reasons.

Most of the discrimination occurs at a fairly small number of elite universities. These are very wealthy institutions. So there is profit in the sense of income exceeding expenses, and maybe even in the sense of return on capital exceeding some appropriate rate. Calculating economic profits here is difficult.

It's important also to identify the residual claimants other than the university itself. I think there is a reasonable case that the tenured faculty members at these schools ought to be considered to hold an equity interest. High salaries, perks, funding for favored research agendas, etc., are all returns on this equity.

Eric Krieg writes:

The issue of for-profit universities...

http://www.businessweek.com/magazine/content/03_46/b3858102_mz021.htm

As a professional getting a masters degree in engineering, part time, it seems that VERY FEW universtities are set up to cater to my needs. They are MUCH too oriented towards full time students aged 18-24.

Their orientation towards these students is what drives tuition increases. These are the people that demand the glossy student union, the high tech excercise facilites, and the gold plated dorms, all of which costs a lot of money.

Me, I just want the most classes offered with the most flexible schedules. Preferabbly the classes would be offered through the Internet, so I don't even have to leave my desk at work.

That can't cost very much.

Could it be that there is a market failure in the university system?

Bernard Yomtov writes:

"Could it be that there is a market failure in the university system?"

Could be, but that doesn't sound like one to me. It sounds more like a simple case of there not being adequate demand to make it attractive for suppliers to provide the product.

Eric Krieg writes:

>>Could be, but that doesn't sound like one to me. It sounds more like a simple case of there not being adequate demand to make it attractive for suppliers to provide the product.

Well, the for-profits think that there is a market.

I think that you are in part correct. There may not be a large market, but only because distance learning hasn't been marketed to the population. And, perhaps, it is a little bit too new.

I think one reason that it hasn't been marketed is that the people who run universities have a bias against distance learning. Which, I think, is the origin of the market failure.

I think that you can see some of the bias when "mainstream" university employees criticise the for-profit colleges for using "non-professionals" (i.e. people who have real world experience in a subject, not an advanced degree).

That is just a stupid criticism. Ask any student which kind of professor they prefer. It ain't the pointy headed dufus with the PhD.

The mainstream university employees are against change. They want to do things the way it has always been done. Sorry, I can't afford that monetarily or even time wise. I need to work to support my family. I can't take time off to get a masters degree.

Luckily, here in Chicago we have a pretty progressive univesity in the Illinois Institute of Technology, that does offer a lot of distance learning classes. Maybe the fact that it is an engineering school makes them different than your average, snobby university.

But even they don't do the best job marketing their distance learning.

Bob Dobalina writes:

"Their orientation towards these students is what drives tuition increases. These are the people that demand the glossy student union, the high tech excercise facilites, and the gold plated dorms, all of which costs a lot of money."

Eric-- I was shocked when, as a student, I saw my school's (Miami University) budget. Only 9% went to PP&E. I don't really know what to make of it, though.

Eric Krieg writes:

PP&E?

Physical plants and equipment?

What is the actual productivity of a university professor in terms of teaching? How many sections does he or she actually teach? How many students?

Universities professors don't do a hell of a lot of teaching. That is where the for-profits focus, having their professors do actual teaching, and leave the research to others.

Xmas writes:

I also have to disagree with you on Universities. First, they are mostly non-profit organizations. Second, I believe that tuition and room and board at universities are simply set to cover costs of the professors' and adminstrators' salaries and also, perhaps, discourage people who aren't serious about completing a degree (in other words, create a barrier of entry for those not inclined to use the school to it's full value.)

Universities live and die by their endowments. Tax-free (as a non-profit organization) interest and dividends off these big balls of capital pay for everything the school needs. The schools feed this money making beast by garnering donations from the alumni. The endowment money is what pays for property (tax-free), research, and all the school's hoopity doo.

You can summarize the University business model as...
1) Gather as many students who are bound to get good paying jobs as possible. Fill the rest of your student body with students who will give the school some sort of prestige.
2) Shove school loyalty down their throats. (Go Harvard! Go Yale! Rah Rah Rah!)
3) Matriculate them.
4) A year later, start calling them asking for donations to feed the endowment.

Xmas writes:

Eric,

Using professors to actually teach classes is not the best way to utilize them. Professors are best use for research and writing papers that get published. Graduate students and TAs are what you use to teach students.

Remember that research means grants (money) and donations (money) and teaming with corporations to create synergy (money) and published papers leads to more research (money). All that money is then used to buy equipment and pay for TAs and graduate students to do more research (money) and handle the teaching of undergrads. New equipment and more grad students means more opportunities for research (money) and more prestige (more money).

Eric Krieg writes:

>>Using professors to actually teach classes is not the best way to utilize them. Professors are best use for research and writing papers that get published. Graduate students and TAs are what you use to teach students.

If only universities told prospective students this BEFORE they enrolled.

You know, I went to community college for 2 years, before transferring to a university. I think that it was the best thing I did, education wise. I never had a class over 35 or 40 students there (even introductory classes) and I NEVER was taught by some dumb ass graduate student.

I'm a graduate student now, and I don't think that I know enough to teach ANYTHING.

Eric Krieg writes:

Ripped off from another blog. A devastating critique of having dumb ass graduate students teach...

SENDING THE WRONG SIGNALS. Invisible Adjunct notes without approval the use of adjunct faculty to teach core courses the tenure-track research faculty would prefer not to teach. She's onto something that sheds light on how far away the great day when our schools educate our children as well as the Pentagon trains our soldiers. (That was an InstaPundit store item years ago; I don't see an InstaPundit store on the site at the moment.) Specifically, think about the recruit's first contact with the armed services: a lifer non-commissioned officer who isn't going to put up with a lot of nonsense, and who has savvy enough to recognize which recruits are in trouble and which recruits ought to be in trouble, most of the time. A novice, or somebody working several jobs, or somebody thinking about how to land one of those research jobs, just isn't the same, and distinguishing the confused question from the sophisticated, if not well posed question is something that comes with practice -- and it helps to have opportunity for questions, something the cattle-call lecture hall the temporary employee often gets as means of production may not have.
posted by Stephen Karlson at 18:30

Mark writes:

"You know, I went to community college for 2 years, before transferring to a university. I think that it was the best thing I did, education wise."

As a community college professor, I am glad to read statements like this.

Eric Krieg writes:

>>As a community college professor, I am glad to read statements like this.

Mark, one of my university professors (Dr. Irving H. Shames, who literally wrote the "bible" for statics and dynamics) used to go on and on about how the kids who took their introductory classes at the university had a much better understanding of the fundamentals than the community college transfer kids.

I think that it was his thesis that the community colleges, with their small classes and whatnot, were a little too "accomodating" to students. Maybe the professors did too much handholding, and there wasn't as much weeding out.

I don't know, I didn't see thing that way. I had no trouble competing. My GPA at the university was as high as it was at the community college.

Bernard Yomtov writes:

Eric,

It's possible both you and Shames are correct. His observations about the average community college student might well be accurate, but tell us nothing about the top end. It's not hard to imagine that the variability is much greater at the community college level than at the university, so while the mean may be lower, the best students could easily be equivalent.

Not that I would expect you to be one of the best students, of course :)

Eric Krieg writes:

Bernard, he could just have been seeing the fact that community colleges have open enrollments, and my university had a floor of about 1100 on the SAT (and, at least back then, the SAT was mostly an IQ test).

I think it would be pretty hard, even for a brilliant guy like Shames, to separate the innate intelligence of a student population from the pedagogical methods of the school. It wasn't like he had a STAKE in the outcome or anything, right?

I don't care what Shames or anyone else says. Huge, impersonal introductory classes suck. If I had a choice, and the costs were similar, I would go with the small classes, like in a community college.

Bernard Yomtov writes:

Smaller classes are better IF the instructor takes advantage of the small size by having more interaction in class, giving more imaginitive (and harder to grade) assignments, and more thorough (and also harder to grade) exams. Another potential advantage is that there is more time available to help individual students outside of class.

But if the instructor doesn't do any of that, and runs a class of 20 the same as a class of 200, you lose the benefit.

Monte writes:

Abnormally high labor costs hurt airlines profits more than anything else (although 9/11 aggravated what was a major shift in consumer demand already underway). Because airlines have little in the way of cash reserves and can’t really afford a prolonged strike, unions continue to press for higher wages.

In the case of private universities, government subsidies to public institutions allow them to offer lower tuition rates. Below cost tuition rates at public colleges is going to draw students away from private colleges.

Do you suppose there’s a connection between academic performance standards and publicly owned and operated universities?

Eric Krieg writes:

>>But if the instructor doesn't do any of that, and runs a class of 20 the same as a class of 200, you lose the benefit.

Even if the professor doesn't change, the smaller class size offers the student more interaction.

I'm one of those bastards that always interupts with questions. Much easier to do in a class of 20 than a class of 200.

Scott writes:

The Apollo Group is a very profitable operation. It runs The University of Phoenix which has campuses across the nation. It’s also the largest private university in the country.

They do a number of things differently. All of their faculty are essentially adjuncts. They don’t have an academic year. Students take one class at a time. Classes are 5-6 weeks in length. Everybody works in a team or study group. (If you don’t like group work, try their Western International University.)

Although they have only taken adult students in the past, they are starting an undergraduate program for students straight out of high school.

It’s a real money making operation.

engine writes:

Back to the airline industry for a second. Airline companies were doing ok under regulation and right after the deregulation. My personal opinion is that the following factors led to major airline companies' (except southwest) poor performance:

1) Fierce competition from low cost carriers (Southwest, Jetblue etc.). This affects their profitability from economy travelers, and more and more from business travelers as well.

2) When economy was good, airlines can earn little (or even lose) money from economy travelers, but earn high price-cost margin from business travelers. But it appears that they were not able to do so in a bad economy.

3) Exogenous factors such as 911 and the resulting low demand and high cost certainly contributed to their poor performance.

carl writes:

every seller would price discriminate, if there weren't two major obstacles in their way: the seller must be able to distinguish who to discriminate - those who are willing and able to pay higher prices and those are not- which can be hard. Also there must be substantial difficulty for a low-price buyer to resell to those willing to buy at a high price. So a price discriminater must be a price maker i.e. monopoly, but still its not always profitable or desirable to discriminate. I'm writing an essay on monopoly price discrimination and would find any comments on whether its profitable or desirable to do so very interesting.

john writes:

i am also writing my paper on monopoly price discrination, hopefully we dont have the same teacher, my teacher is Zill

Comments for this entry have been closed
Return to top