What looks like a discount is not actually a discount

What is the goal of any firm,  store, mall, service provider or even a rocket factory? The answer is, either earning enough money(Accounting profit) to run the business, and cover operational costs (variable costs), or filling the stakeholder pocket’s with more profits (Economic profits), which include the accounting profit in its calculation and the opportunity cost forgone from running a different business.

Let us keep it simple, firms aim to make economic profits, but it would not
mind so much if it is stuck with accounting profits.What can firms do? Well
this requires good managers, financial analysts, smart accountants, production factors, and some microeconomics

Assume that we have a firm that is doing a good job, or it has some power over its prices, hence, this market is an imperfect competitive market. The Demand curve of this firm’s product/service is downward, which means higher prices would distort sales. Nevertheless, remember that higher prices mean more bucks in the pockets. Therefore, firms always have an incentive to charge higher prices, along with selling more products to accesses their economic profits, while equating the firm’s marginal revenue with marginal cost (Profit maximizing condition)

Firms can use magicians to flip aside the demand curve and make it upward slopping. Unfortunately, I cannot recommend the former trick, because I suspect its applicability. However, Microeconomics proposes a different trick.

Firms can achieve this by more costly and sophisticated ways, either establishing good connections with Government officials to restrict entering this market along with producing a product that is needed and has no close substitutes (AKA. monopolist), or to dowhat is known as imperfect price discrimination (Market segmentation).

The idea here is to sell the same product at different prices for different consumers, depending upon their price sensitivities. Conclusively, people who tend to be more sensitive (segment 2) should be assigned lower prices; others should have high prices (Segment 1). As elasticity rises, people will be willing to pay lower prices for this product or service, because of their preferences, accessibility of closer substitutes, income, age, etc…. For example, when you regularly do your weekly shopping from the grocery store nearby, and a big, shiny advertisement blocks your way, which
announces that you can buy more of your favorite jam with lower price, buy one with 40 cents, 2 with 75 cents and three with 1.05 cent. Your mind
automatically deduce the total price of buying 3 single jars with 40 cents each (price of a single jar in this offer) and the total price of 3 jars in this
offer(1.05 cents), so the difference will save you 15 cents.

This is what I was talking about, this offer is not for the sake of consumers, otherwise the grocery manager is trying to price discriminate you ( or run you along your demand curve) and guess what he always wins. Because the profit from selling only one jam jar with say 30 cents (lowest price possible to instigate sales) is lower than his profit from the discrimination strategy (both cases, he assign a price higher than his marginal cost). Therefore, what looks like a discount for you, is simply a technique of profits accession for the owner.

Successful Price discrimination based upon the uniqueness of sold product and the inability to resell this product (Taking benefit from price differentials between consumers). We can find price discrimination strategies in airline industries at which the price of last minute traveler ticket is higher than regular ticket prices (regular in sense of their rush and the opportunity cost of their times which determines their willingness to pay).

At cinemas, children are usually offered lower ticket prices, because they tend to buy pop corn, cola and stuff, which would cover up the discounted value of their tickets. Juniors tend to have discounts at their outlets, because they are price sensitive, and tend to have more time to search for cheaper alternatives than older people do.

Tip for sellers:

– Your challenge is to find ways to know people willingness to pay while segmenting your markets (as people do not walk with their elasticity coefficients on their shirts), make unique products, and make it harder to resell your sold units. The more accurate you deduce the degree of sensitivity of your costumers, the more successfully you will be able to price discriminate and earn more profits.

Tip for buyers

– Do not be so inelastic; do not give any signals implicitly or explicitly to sellers that you are eager to buy this product now, and spend some time searching for better and cheaper alternatives.

Sure thing, this simple analysis misses a lot of salient information about firm’s pricing and producing behaviors.

 

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Author: Sherif M. Hassan

Sherif Maher Hassan is a member of the academic council of M&S Research Hub (www.ms-researchhub.com), he has been a research affiliate at the Global Labor Network (GLO) since 2017, a research associate at the Economic Research Forum (ERF) since 2018, a member in the Eurasia Business and Economics Society (EBES) and International Institute of Social and Economic Sciences (IISEC). His current research focuses in general on development economics, particulary political economy, demographic changes, migration and fertility behavior. He holds a Ph.D. in Economics from Philipps University of Marburg, an MA in Economics and political science from the same university and a joint MSc in Economics from Suez Canal and Cairo Universities.

One thought on “What looks like a discount is not actually a discount”

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