In his oft-cited book The Economics of Price Discrimination Louis Phlips wrote that “the more one thinks about price discrimination, the harder it is to define”. I tend to agree with him. Reading reactions around the blogosphere to Spirit Airlines recent decision to begin charging for carry-on bags I’ve begun to realize that there is lack of a clear understanding about what price discrimination is and what it isn’t. I have up until today been focused on the theoretical implication of price discrimination given that there is price discrimination, rather than bothering to think hard about whether or not price discrimination was occurring. But the more I think about this the more I’ve come to the realization that charging for carry-on bags is not price discrimination per se, and that whether or not it is price discrimination depends on the details.
A simple definition of discrimination is when people pay different prices for the same good. A more nuanced definition is offered by Phlips, who says that price discrimination is when:
…two varieties of the same commodity are sold (by the same seller) to two buyers at different net prices, the net price being the price (paid by the buyer) corrected for the cost associated with the product differentiation…. My criterion clearly refers to a cost associated with a change in the characteristics content of a product. Transportation and storage costs are examples that readily come to mind. Costs of product design and of changes in specifications and of services offered by distributers are perhaps less obvious examples.
In this example, carry-on bags might be considered storage costs, or an additional service. The question then seems to be, does the price reflect the additional cost, or is the price differential unjustifiably large and thus an attempt to extract surplus from a segment of the market that has a higher willingness to play for plane tickets? The answer to this is not obvious to me.
Offering some guidance, Phlips gives a similar example that he identifies as price discrimination:
Discrimination is revealed, for example, when people flying tourist class discover that first-class passengers enjoy a service (perhaps champagne or caviar) that is much better than is justified by the difference between tourist and first-class fares, that is the service has a higher “worth per dollar.”
Another comparable scenario is my example of movie popcorn that Matt Yglesias cited. The reason that price discrimination is occurring here is that the price charged for the popcorn in a movie theater is obviously higher than the for popcorn outside of a movie theater, thus price discrimination. The difference in the baggage example is that we don’t have some other market where we can observe comparable prices for carry-ons to determine whether the $30 to $40 Spirit is charging is reflective of the cost. In short, you can’t buy carry-on service outside of an airplane.
Part of the challenge is to determine what should you consider the cost of supplying carry-on space. If the flight is not full and there is plenty of unused carry-on space, then the price might be zero. In contrast, if there would be shortage of carry-on space if it were free, then one could consider the cost to be the opportunity cost of the scarce resource. One rough estimate of this might be to imagine that carry-on space were auctioned before each flight and ask what would prices end up at. Would it be more than or less than $30 to $40?
If someone else has a better definition or understanding of price discrimination and can offer a more decisive analysis I’d be glad to hear it.