Has anyone ever told you not to wear nice clothes to the market? Apparently, the nicer you look, the higher vendors will quote their prices. As some will say, "don't let them use you." Economists refer to this 'using' as price discrimination, where different customers are charged different prices for essentially the same product.
Here is an illustration of an explicit form of price discrimination in Nigeria:
Imagine going to the market to buy a bag of rice. You wind down the window of your Land Cruiser and signal the market-woman over to you, flashing your gold watch in the process. Glimpsing this, she does a quick calculation - the going rate of the bag is ₦7000 but she deduces that a big madam like you would be willing to pay more – after all, big madams rarely haggle. "Ma, the bag is ₦8000," she says. You buy it and drive off. 30 minutes later, I arrive on an okada to buy a similar bag. Eyeing me from head to toe, she figures I am too sharp to be used, and I will swiftly patronise a competitor if tested. "One bag is ₦7500". After some haggling, I buy the bag for ₦7100.
Had the market-woman tried to sell at a uniform price – say ₦7500 – she would have lost a customer and allowed the big madam buy it for ₦500 cheaper. But by guessing the willingness to pay of each customer and charging different prices, she extracted much more profit.
Price discrimination lurks everywhere. Some examples are blatant and annoying, like Uber's surge pricing; others are older and more discreet. For example, coupons are yet to catch on in Nigeria but are a staple of retail culture in richer countries. You see it in the informal and formal sectors. And if you pay attention, you will notice the tricks.
Recently, I went to KFC and ordered a chicken burger sans cheese. Adding cheese would cost a whopping ₦250. Extra cheese doesn't cost KFC ₦250 but by asking for it, I signal that I have a higher willingness to pay. Unlike the market-woman, KFC cannot charge prices based on how people look, so it entices them to reveal themselves. Economists term this self-selection.
Price Discrimination Can Be Good
Is price discrimination good? Like with all things in economics, it depends. Firstly, notice that consumers are not innocent in this pricing game. We have our own ammunition; for Nigerians, it is 'last price, how much?' You're unlikely to find yourself accused of cheating a seller simply because you tried to find the lowest price he would sell for.
As an individual, it may be annoying to discover that you paid more for the same product but price discrimination has several social benefits. Surprisingly, it can lead to both a more efficient and potentially fairer outcome, the holy grail of economics.
Consider an example provided by Tim Harford in The Undercover Economist, where a pharmaceutical company develops a uniquely powerful HIV drug. A uniform global price would be prohibitively expensive for the very poor – a group likely to be disproportionately in need of the drug – while wealthier individuals would be willing to pay thousands of dollars. Not only is this unfair, it is also inefficient as the drug company would rather sell to as many people as possible, as long as the price remains above the marginal cost of production.
Say it costs $10 to produce another unit of the drug and it is sold at a global price of $1000. Many poor people will not buy it. By introducing two-tier pricing, say, $100 in poor countries and $1000 everywhere else, we get a more efficient and potentially fairer outcome.
Fairness vs. Efficiency
While it's easy to see how price discrimination made things more efficient in the HIV drug scenario, fairness is not as simple. For instance, poor people in developed countries would baulk at having to pay $1000 for the drug; why should they be treated differently from the poor elsewhere? These questions are hard to answer; economics cannot help us when fairness conflicts with efficiency.
But some cases are clear cut. Usually, producers price discriminate to subsidise a separate group of consumers. Pensioner and student discounts are good examples. It's probably fair to say that a pensioner should pay less for a bus journey (which happens in many developed countries) but what if there's a desperate businessman willing to get on the bus and pay double for that seat? The discount is now inefficient as we could bribe the pensioner, who is presumably not in a hurry, to wait for another bus and take the desperate businessman's higher fare, leaving everyone better off.
But as price discrimination has become more pervasive, it's a lot more difficult to figure out the ethical basis for segmentation. Should price discrimination be done by nationality? Should firms be allowed to use data they collect about you online? Should they only use this pricing method when it suits them? Your guess is as good as mine. As we have argued before, fair prices are hard to pin down.
In all this, we can agree that price discrimination is not outright cheating. You are never compelled to purchase an item at a particular price. You can forego the ₦250 cheese in your burger and you can threaten the market-woman that you will patronise a competitor with lower prices. As the HIV and bus fare examples showed, price discrimination can be used to get a better deal for the less fortunate. Take a final example of the CBN's multiple exchange rates. Some individuals such as SMEs, petroleum importers and airlines get better rates than those going on holiday who apply for Personal Travel Allowance. In this scenario, the CBN has decided that these special dollar customers are perhaps more important than holiday goers and international school students.