My fellow bloggers seem to have the big picture in focus. Here's something a little smaller. In my Principles class, I have students read this clever Slate article on price discrimination, "The mystery of the rude waiter," by Tim Harford.
http://www.slate.com/id/2134489/
He suggests that a restaurant may deliberately employ a rude waiter in the bar, in order to discriminate, charging a high price in the dining room and a lower price in the bar for the same food. The rude waiter keeps the high rollers in the dining room - it's the hurdle that the low willingness-to-pay customers jump to get the lower price.
Here are some numbers that I use to illustrate Harford's point. Suppose there are two potential customers, rich and poor. The rich person will pay up to $24 for a meal with decent service, but only $11 for a meal served badly. The numbers for the poor person are $10 and $9, respectively. The cost of a meal is $5. The differential in each case is the Willingness-to-Pay for good service, which is higher for the rich than for the poor. Without the rude waiter, the seller would charge $24, sell to the rich only, and make profits of $19 (this beats the $10 profit he could make serving both at a price of $10). With the rude waiter, he will set the price in the bar at $9 and the price in the dining room at a little less than $22. The rich person then chooses the dining room, getting consumer surplus of a little bit more than $2 ($24 minus a little bit less than $22), as opposed to the $2 surplus ($11 -$9) he would get eating in the bar. The seller's profits are then $31 - $10 = $21.
Harford then discusses price discrimination through quality degradation generally (where the lower quality version of the good is the high quality version with resources spent to degrade it!). Do these possibilities worry Tim? Not a bit of it. In good "real is rational / what me worry?" fashion he asks "what are the alternatives?": the crux is that without price discrimination, the seller "could have passed up the opportunity to serve low-end customers altogether. That would have been no better."
Yes. Well, I chose numbers where that is true, but it needn't be. In my example, change the rich person's willingness to pay to $14. Now, if unable to discriminate, the seller does best to sell to both at $10 each, earning profits of $10. The discriminatory price scheme would set the bar price at $9 as before, and the dining room price at a bit less than $12, thus giving profits of (a bit less than) $11. Compared to the no-discrimination outcome, net benefits are obviously lower, since total value drops by $1 due to the degradation, while costs are identical. If the degradation costs something (and the seller would be willing to spend up to the $1 increase in profits to degrade if necessary) - say the waiter must get extra compensation to make up for the disutility of being mean-the efficiency loss is even greater. Funny how this second possibility gets overlooked. Dr. Pangloss, call your office!
12 comments:
Kevin,
I'm curious to know where it is that you dine. I haven't yet found a restaurant that has a bar menu for less, unless the portions are smaller. Even that's hard to identify. in higher end places the bar is strictly for waiting and spending money on booze during the wait. There is no incentive to seat the patrones quickly.
Frankly, I can't make heads nor tails out of the concept of higher quality goods being degraded at extra cost, resulting in lower quality goods. Are the lower qualilty goods to be sold at a lower price? And where does the concept come from to begin with? The difficulty is on the buyer's side, having to determine is the lower cost of a product is equal to or greater than the lower quality of that product. This may be referred to as the China Syndrome or, Is shopping at WalMart really such a bargain?
I have been in a few such places, although not many. However, offhand, I do not particularly remember any outstanding examples of the waiters being rude in any of them, although the concept is certainly theoretically reasonable. Maybe this is some British syndrome. Isn't Harford a Brit?
Barkley
The rich person will pay up to $24 for a meal with decent service, but only $11 for a meal served badly. The numbers for the poor person are $10 and $9, respectively.
Dammit, everything is so cheap there. Here in Europe you'll pay at least $35 for any meal with any friggin service. And the portions are about a quarter of the US ones.
Oh, well.
abb1
Barkley,
It's not likely to have anything to do with restaurants in England.
In the pubs the food is good, flavorful and plentiful, a hearty meal so to speak. All at one price level. In the restaurants only the Indian style provides anything that would approximate a reasonably priced meal. If the style is Italian watch out for ketchup substituting for pasta sauce. If the style is general continental there is no concept of less expensive. You'll be lucky if the food at least tastes decent. There is a serious discrepency between the concepts of English and good food. Stick with fish and chips.
anon,
Don't jump to conclusions. Kevin's dollar amounts are strictly hypothetical, having nothing to do with the actual price of retaurant food in the US. He may be dining in Applebees or McDonalds at the prices he's listed. A good meal in Manhattan is not less than $50 plus wine, tip and tax, and mostly more than that.
The rude waiter also does important work helping to increase turnover. I used to go to a tiny Chinese restaurant in San Francisco. The waiter -- Edsel Ford was supposed to be his name, but he hardly spoke English so I could never ask him his given name -- was famous in the city for the rudeness. People used to go there to see him operate.
Jack: Here are some examples of degradation from the article:
"Intel introduced two versions of the old 486 computer chip; the cheaper version was the expensive version with some extra work done on the chip to reduce its speed. IBM's LaserWriter E, a low-end laser printer, turned out to be exactly the same piece of equipment as their high-end LaserWriter - except that there was an additional chip in the cheaper version to slow it down."
Veblen wouldn't have been surprised. Industrial sabotage!
Kevin,
But what's the benefit to either IBM or Intel in spending more to make less. Planned obsolescence has utility to the producer. Making a product longer lasting may actually reduce sales in the future, though its a slippery path to follow. Simply producing or distributing cheap stuff seems like the way to go given the WalMart phenomenon and China's success generally. But why add cost of production to do so?
Jack,
The seller would like to charge each buyer the most that buyer would pay (like a good car salesman) - that would maximize profits. But there are two problems: they don't know who the high willingness-to-pay customers are; and charging higher prices to some customers would open up an oppportunity for arbitrage - those getting the lower price can increase purchases to resell to those who would otherwise pay the higher price, causing the scheme to fall apart. Producing a degraded version that sells for a lower price, even at some extra cost, solves both problems: as long as willingness to pay for the good itself is correlated with willingness to pay for quality, those who buy the higher-quality version reveal themselves to be the high willingness-to-pay customers and are charged accordingly. And those who buy the high quality version could have purchased the lower quality version and didn't, so there is no arbitrage possibility to be ezploited.
On Kevin's point about the 486. I am totally convinced that the 'free' phone you get with a service plan is deliberately designed to be hard to use. My first cell phone seemed to have most of the actual features of any other phone but was maddeningly difficult to figure out. It's whole intent seemed designed to drive you to a higher end phone.
Who on earth would pay $499 for an iPhone when Verizon had given me a free one? Well to tell the truth I didn't actually get the iPhone for its phone features. Still I can say that I know how to check voicemail and add contacts which is a lot more than I can say about my old phone.
It's a similar principle to car pricing, where you go on the lot wanting to look at that car 'starting at $14,999' and drive off the lot with one 'comfortably equipped for $23,499"
Being an engineer, I still remember the revulsion from the first instance I witnessed and recognized of deliberately damaged goods for purposes of price discrimination: Digital Equipment (once the #1 maker of minicomputers, now long out of business) "MicroVax" mini was very successful, and soon they introduced a cheaper model that only differed by the number of expansion slots available on the bus. On opening up the cheaper model, you saw that a couple of the expansion slots had been disabled by carefully filling them up with tar...:-(. I had *read* about similar occurrences (e.g., several that IBM was alleged to have perpetrated long earlier), but seeing it with my own eyes was PAINFUL (for an engineer)...
Here is a brief selection from my book, Steal This Idea, regarding efforts to desable useful features of technology to increase profits.
"... companies go to great lengths to develop or modify technologies in ways that have no purpose except to protect intellectual property. For example, in the 1970s and early 1980s, many software companies went to great lengths to create measures to complicate efforts to duplicate software in an effort to protect their intellectual property. In the process, they made their own software more inconvenient to install, if not to use. Even today, the installation of software often requires the keying in of long sequences of numbers, creating a nuisance every time that software needs to be reinstalled.
In other cases, corporations spend money to make their products less useful to capture more rents from their products. For example, Intel purposely disabled the math coprocessor in the lower cost Pentium SX chip to encourage customers to purchase its more expensive products. The Recording Industry Association of America (RIAA), composed of member companies responsible for almost 90 percent of the prerecorded music produced in the United States, goes to great lengths to make the duplication of music more difficult.
For example, in the 1980s the RIAA pressured Congress to limit the capacity of digital audio technologies. Congress dutifully responded with the Audio Home Recording Act of 1992, which required producers of digital recording devices to install a chip in their system that implements a code-based system to monitor the copies of any copy made on each machine (see Lessig 1999, p. 46; and Horner 1991). More recently, Creative Labs developed a new portable MP3 player with a built-in FM radio that can record radio music. The company had to engineer it to record with low quality to avoid being sued by the recording industry (B. King 2000). In sum, industries that produce technologies capable of reproducing recorded music must include technologies that disable the capability of duplication, or at least impose difficulties on those who would like to duplicate. As a result, consumers must pay extra the costs of developing and producing technologies designed to restrict products' usefulness.
IBM, Intel, Toshiba, and Matsushita Electric have jointly developed a new technology for the convenience of copyright owners. The technology, known as Content Protection for Recordable Media, or CPRM, allows content producers to specify how many times a consumer can copy a given file. When you buy and download, your MP3 player would use the rights-protection system and the serial number already on your memory card or disk to encrypt the file and create a unique "key" for it. That key lets the music player know whether or not the file is stored on an authorized disk or memory chip. When you want to listen to your album, the player checks for the digital key; if everything matches up, the file is decrypted and your music will begin to play. The copy-protection system will not work unless it is deployed in the original files, in storage media, and in media players. To add insult to injury, consumers will have to pay for the necessary hardware, as well as royalties to the owners of the technology to interfere with consumer behavior.
Microsoft has built its new XP operating system in a way that severely limits the quality of sound that can be recorded as an MP3 file. The system is designed to work with non-MP3 music-software formats that include technology known as digital-rights management, which can "lock" copyright-protected songs and make it difficult for consumers to share music. Dave Fester, a general manager in Microsoft's Digital Media Division, arrogantly asserted, "We think at the end of the day, consumers don't really care what format they [record] in" (Bridis 2001).
New DVD players provide a Regional Code Enhancement, but this enhancement your use of the equipment. Instead, this enhancement prevents you from watching a DVD sold in another region. For example, region 1 discs would only play in the United States.
What pressing reason demands Regional Code Enhancement? Movie studios maximize their profits by staggering the release of titles on videotape and DVD in different regions following the schedule of their cinema releases. So they want to prevent people from watching a film before it is released in their region (Fox 2000). University of California, Berkeley, Law Professor, Pamela Samuelson observed, "These groups seem to believe they are so important to America that they should be allowed to control every facet of what Americans do with digital information. They also seem to think they are entitled to control the design and manufacture of all information technologies that can process digital information" (Samuelson 1999).
The efforts to cripple the usefulness of technology do not always succeed. For example, Hollywood faced a crisis in new technology. The president of the Motion Picture Association of America, Jack Valenti, in testifying before the House Judiciary Committee, roared, "The growing and dangerous intrusion of this new technology [threatens an entire industry's] economic vitality and future security. [The new technology] is to the American film producer and the American public as the Boston Strangler is to the woman alone" (cited in Liptak 2000). The alert reader might notice the dated reference to the Boston Strangler. Mr. Valenti was testifying in 1982 against the threat posed by videocassette recorders.
You may have noticed that the industry is still earning healthy profits, despite the introduction of this murderous technology. Was Mr. Valenti correct or was the industry saved by the inclusion of technology to making the copying of videos more difficult? In the current regime of intellectual property rights, Mr. Valenti would certainly be more likely to succeed in impeding the introduction of the VCR.
At the time of this writing, the industry is pressing the Federal Communication Commissions to require virtually every digital device to include special circuitry to make copying of future digital television signals all but impossible. The industry plan would render the existing generation of already very expensive high-definition television sets incapable of viewing many digital programs. It would also prevent households from recording shows on their VCRs. The construction of all of these technological impediments to using technology goes hand in hand with the legal actions to crush those who would provide more convenient ways to copy music, as in the case of Napster.
Restrictions on intellectual property do not make sense, even by the narrow criterion of profits. Napster actually seemed to increase sales of CDs, by allowing people to become familiar with new music. Video rental income now rivals box-office receipts for movies (Liptak 2000). In the case of software, copying often helps to improve the product and, more important, to establish a program as a standard (Perelman 1991).
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