Rethinking the Efficiency of Price Discrimination

Abstract

Analysis of efficiency in legal fields from contracts to competition assumes that a consumer’s demand depends on the price the consumer faces, not on the prices a firm charges other customers. This project provides evidence to the contrary. It examines how the phenomenon impacts the analysis of personalized pricing, also known as perfect or first-degree price discrimination. Courts have long considered the practice efficient, and companies increasingly use big data to that end.

The paper reports the results of a sequence of experiments on a simple transaction: flatware purchases. When participants learned about a firm’s personalized-pricing mechanism, demand contracted by up to 24.8%. I model a company’s most profitable response to this behavior — namely, keeping consumers in the dark about personalization — and find that the ensuing demand-side inefficiency can dwarf that of uniform monopoly pricing.

Because personalized pricing has galvanized an industry of transparency-focused startups, I also model a company’s response when it cannot obscure its pricing mechanism. Its second-best strategy is to sell to a narrow range of high-value customers. Doing so excludes some lower-income or less-interested consumers from the market. This prompts a supply-side inefficiency that can also exceed that of uniform monopoly pricing.

Faithfully applying the consumer-welfare approach to these results suggests an expanded paradigm and new types of antitrust harms. Both strategies — opaqueness and exclusion — can lead to violations of the Sherman Act and facilitate showings of harm under the Robinson Patman Act. As such, this project supports policies aimed at the transparency of prices.