Should we help companies tailor prices to your wage packet?

Discretionary pricing… for scientists and surveyors. Hidden Science Map, CC BY-NC-ND

There is a broad consensus that income inequality (within developed countries) has increased and that governments should act to reduce this.

However, the conventional policy remedies – such as more progressive income taxes – remain divisive and politicians are seeking alternatives. One tool has been overlooked: governments can enable price-discrimination by income and effectively reduce costs for poorer households.

Price discrimination is a simple concept. Where individuals have a different willingness to pay, firms can benefit by finding ways to charge some consumers more than others. Companies spend vast sums hiring “big data” consultants to find the best way to divide consumers into segments. They can then charge them different prices through targeted discounts or coupons, store-specific pricing, or internet cookies which can gauge your preferences and ability to pay. To maximise profit, firms want to identify the most you would be willing to pay – and then charge you that price.

Of course, a firm typically doesn’t know exactly what you would be willing to pay for its goods or services. Second-degree price discrimination is where a company presents multiple products, trying to induce the higher-value consumers to choose the pricier options. They may offer both an excessively-luxurious product and a discount version designed to be inferior, or that requires clipping a coupon, queuing or waking up early. These practices bring highly-visible waste and inefficiency.

Income support. Expanding discounting to the masses. Laurie Pink, CC BY-NC-ND

Then you can get third-degree price discrimination which occurs where a firm charges different prices for the same products to observably different groups. They may offer special discounts to students or pensioners, who tend to put lower valuations on products and services.

The ability to pay

The conventional textbook wisdom is that income is among the strongest determinants of willingness to pay. Empirical work typically finds that price sensitivity decreases as income rises.

If firms knew everyone’s income they would offer higher prices to the rich than to the poor. They would do this to profit, not to play Robin Hood. Why then, do low-income consumers not face lower prices?

The key is that third-degree price discrimination requires identification. While students and pensioners have university and government-issued IDs, firms cannot easily identify low-income consumers.

However, governments do compel people to report their income (and wealth, family status and the rest) to administer taxes and benefits and could, therefore, offer consumers a card which declares their income, or perhaps a more complex assessment of their well-being which combines a selection of data. We can call this an “OpportunityCard”. Japan recently introduced a digital-ID that encapsulated this information, but strictly limited its use mainly to the administration of taxes and benefits.

Price discrimination. Something for everyone? Stéphanie Kilgast, CC BY-NC-ND

Consumers could present this OpportunityCard to merchants, who would typically profit from charging a high base price and offering greater discounts to consumers whose cards reveal lower incomes. Discounts for lower-income OpportunityCard holders would increase their purchasing power, while the reverse is likely to hold for wealthier consumers. This will act to reduce inequality, at least in terms of consumption.

Value judgements

Left-of-centre politicians see income inequality as a serious social ill. Centre-right politicians such as David Cameron praise the power of open markets and criticise the “top-down, interventionist state.” The OpportunityCard can make both sides happy – reducing inequality through market forces, strengthening rather than hindering the “invisible hand” of markets.

Naturally, price discrimination brings winners and losers. In general, groups who value a service or product more will be charged more, but not every individual within each group will have the same valuation. Because of the differential pricing, the “wrong person” might be drawn to part with their cash. Simply put, a purchase is made by someone who gets less out of it than another potential consumer who decides to hold fire. For the card to increase efficiency in spite of this, it must substantially increase overall output. Those net results, however, can go in either direction.

Is it workable?

It is also worth questioning whether people would use this – or whether it would become some stigmatised evidence suggesting (economic) underachievement? Well, for a start, we cannot predict how widely the OpportunityCard would be accepted. However, it could be made mainstream and available across a range of incomes (“the 99%”) and even the comfortably-off middle-class could get some discounts. It may be used discreetly, like supermarket loyalty cards. There is precedent: more than 40m low-income Americans regularly use Food Stamp cards – and across the UK people claim subsidised council housing.

Old stamping ground. US citizens get help with groceries. chrstphre ㋛ campbell, CC BY

You might also wonder if the wealthy would simply hire those on lower incomes to purchase goods on their behalf? We think sellers would anticipate this, and offer discounts only where they don’t expect this “arbitrage” to occur. However, for many products – such as bus passes with photo-IDs and airline tickets – arbitrage is difficult or impossible. For small-ticket items it simply isn’t worth the bother: we don’t see crowds standing outside of supermarkets trading multi-buy tissue boxes, and nor do we see people (at least, not many) reselling jars of mayonnaise on eBay.

As we have seen, companies do try to do this in an ad hoc way with discounts and targeted branding, but they can’t go the whole hog into discretionary pricing unless government enables it through something like the OpportunityCard. The rules and regulations for price discrimination are often complicated and misunderstood. Verifying income is certainly cumbersome for small transactions. That is why a centralised card could solve this problem.

Gaining experience

While an OpportunityCard is likely to help the poor and boost profits, we don’t know whether it will be an efficient way to do this. The costs and benefits for the production and allocation of goods is uncertain. Furthermore, as with means-tested benefits, there will be an impact on the labour market. So, the traditional way for governments to play Robin Hood – taxes and benefits – may be less or more efficient. We simply do not know. We also don’t know whether issues such as stigma, fraud and arbitrage will prove serious impediments.

We can only learn by experience, testing and measurement. Controlled field experiments and policy trials can be run, measuring impacts on prices, demand, and output. The OpportunityCard could be gradually introduced to a random selection of consumers, regions, or industries. Distinct administration and marketing techniques should be tested, and focus-groups and surveys could gauge attitudes. Economists and policymakers could use the evidence to infer where, how and whether to introduce the card more widely. If we don’t test, of course, we risk missing out on a valuable tool for improving both equity and efficiency.

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