Price Discrimination and Secondary Markets

I can’t sleep and I’m thinking about secondary markets so I figured I would write something since I haven’t done that in a while.

Secondary markets is a rather vague term which could be vaguely described as sale by consumers of their used items. Examples of participants would be used-book stores, thrift stores, Craigslist and Ebay. Over the years, many industries have seen secondary markets as competition and reacted accordingly by lowering their prices and providing better products lobbying to get those markets banned with varying levels of success. But is that actually in the economic interest of the original producer? I would argue not. I would argue that secondary markets act as price-discriminators and are actually helpful to the original producer.

First, let’s review what price discrimination is. Price discrimination is when two different people are charged different prices for the same item. Why would a producer want to do that? Ideally, producers would like to charge everyone their reservation price for a good. So for instance, if Alice is willing to pay $10 for the good and Bob is willing to pay $2 and the marginal production cost is $2, producers would like to price Alice $10 and Bob $2 taking in $8 in profits. But in most standard models, the producer cannot do so. The producer does not know what everyone’s reservation price is. So the produce charges the MC and makes no economic profit.

So how can I price discriminate? Well, I might not be able to ask everyone their reservation price, but I can surely segment my market into different cohorts and make people signal what cohort they are in. For instance, higher income people are generally willing to pay more than lower-income people. So how can I force people to reveal whether they are higher or lower-income people? Well, I can make coupons available. Let’s say I put out a $30 coupon which one can discover and obtain given some 1hr of work. Now, people will self-segment. If I am low income, $30 for 1 hour of work is a good deal. But if I am high income, that isn’t worth my time. I might as well work a little more and make more money. So the coupon allows the poor people to prove they are poor without bringing in their W2.

So now look at secondary markets. Secondary markets despite the great advances that have been made are still quite difficult to use. I have participated in the secondary markets for books and a variety of other goods and it is quite time consuming. So let’s imagine a book that is sold for $50 originally. The poorer customer might only be able to afford $25. That is of course mostly economic profit (MC~=0) so the producer would very much like to make that sale. So what happens? The customer purchases the book spending $50. But then when he is done with the book, he turns around and resells the book for $25. In effect, a private coupon of sorts has been issued by the promise of future participation in the secondary market. Again, only the poorer participants will chose to use the “coupon”. The wealthier person does not want to spend time interacting with the secondary market. On the other hand, for the poorer people, the secondary market is a good deal. They can spend time and energy (which they have) instead of money (which they do have not) to get what they need.

Don’t shut down the secondary markets. They help everyone.

About these ads
This entry was posted in Economics. Bookmark the permalink.

One Response to Price Discrimination and Secondary Markets

  1. Bill says:

    I’m told that this analysis, as it applies to used text books, was, at one time, standard fare in economics classes at UCLA.

Comments are closed.