Adam Ozimek says that though price discrimination can enhance welfare we shouldn’t be so quick to assume that what airlines do is always optimal, because it can lead to inefficient bargain-hunting behavior:
One way that airlines price discriminate is to offer tickets at a discount if the person is willing to stay over saturday night. Because businessmen are typically unwilling to stay longer than they need to and are also less price sensitive, this allows airlines to offer a discount only to the more price sensitive leisure segment of the market… thus price discrimination. The inefficiency arises because people staying longer than they otherwise would is a distortion, and the loss of welfare due to distortions like these can more than offset the welfare gains from the discount. This cost of separating the market can make price discrimination on net less socially optimal than not price discriminating in the first place.
There are other ways price discrimination by a monopolist can be socially suboptimal, but Matt’s point that they can also be socially optimal is the less understood point, so overall I can forgive him for not getting it quite right.
I would say the issue here is that the “stay over a Saturday night” discount just isn’t a particularly accurate way of segmenting the market. If there were some way for the airline to just know who’s traveling for business and who’s traveling for leisure, then the price discrimination resulting from that would be clearly beneficial. Efforts to differentiate prices via unbundling, like the bag fee, strike me as more akin to his example about movie popcorn:
It turns out that even at the margin, and even given that price is already high enough to cover costs, higher popcorn prices may make consumers overall better off. How can this be? This paper explains that total consumer welfare can go up when producers use “metered” price discrimination. This is where consumers are charged more for “aftermarket goods” (the popcorn) and charged less for the primary good (the movie ticket). This type of pricing scheme can benefit both producers and consumers; the theater can charge a lower ticket price, which means that some consumers who would have been priced out of seeing the movie instead choose to attend the movie at the lower price. The paper provides evidence that this type of price discrimination is in fact occurring.
So the next time you’re barely willing to pay the ticket price to see a movie, thank the customers grumbling about their $10 buckets of popcorn.
At any rate, as I said in the update to my initial post the best thing for consumers and society is to promote competition, where possible. But it’s important for people to understand that it’s essentially impossible to create perfectly competitive markets in many instances. For example, in Washington DC if you want to go see Greenberg (which is good, but no Squid and the Whale) there’s only one theater showing it. And, indeed, this is generally the case for independent or foreign films. You go to Landmark E Street Theater or you don’t go at all.
Of course that’s not to say there are no competitive pressures on the theater — in the general “entertainment” market there are lots of other options — but the pressure is still quite imperfect. The fact of the matter, however, is that a given city is only going to be big enough to support so many movie theaters. A city of 600,000 people is never going to have so many theaters as to meet the ideal of a perfectly competitive market for opportunities to go see Kick-Ass. Comprehension regulation of movie theaters to eliminate deadweight loss from prices that exceed marginal cost seems likely to be a cure worse than the disease. So price discrimination is the best solution available.