Memo to WaPo: Price discrimination does not imply monopoly
In a blog post at the Washington Post’s “The Switch” site yesterday, the usually reliable Timothy B. Lee set out to analyze pricing in the market for Internet access services. I have a lot of respect for Tim, but his blog contains some pretty fundamental economic errors that need to be set straight.
Most important, the blog buys into the long-discredited notion that price discrimination implies monopoly power. Reviewing Comcast’s tiered pricing plans (faster access costs more), it concludes – correctly – that “Comcast is engaged in what economists call price discrimination.” But then it goes on to opine that “Comcast’s strategy only works because Comcast faces limited competition in many markets.” That’s wrong.
Economists have understood since at least the early 1980s that price discrimination can and does occur in competitive markets where there are large sunk costs. (Then, the issue was airline pricing.) Not only that, but it is widely understood that price discrimination in such markets is not only possible, but necessary, and not only innocuous, but welfare maximizing.
I would be remiss if I failed to point out that much of the seminal work on this topic was done right here at AEI, by Bill Baumol and others. As Baumol concluded in a 2005 AEI Distinguished Lecture, in high tech markets “discriminatory prices are not haphazard in their welfare properties but will generally constitute a Ramsey optimum.” But I should also note that the concept is accepted by virtually all competition economists, and that there is widespread agreement that it occurs in high-tech markets. As Jonathan Baker wrote (a decade ago):
“Competitive price discrimination is probably found most commonly in high-technology markets and other industries with low marginal cost, high fixed costs, and some product differentiation. In such markets, it may be necessary for sellers to charge at least some customers prices in excess of marginal cost in order to make it profitable for firms to enter the market (by covering fixed costs) or stay there (to the extent the fixed costs are not sunk). Marginal cost pricing, the usual competitive benchmark, may thus be infeasible.”
If you’re interested in this, you can find a longer discussion, and citations to the Baker article and other relevant literature, in my paper on Broadband Competition in the Internet Ecosystem (around pages 16-17).
There are some other aspects of the blog worth quibbling with. For example, the statement that “the hallmark of competitive technology markets is that consumers are routinely given more than they think they need” is a good example of one that sounds nice when you read it once but wouldn’t pass muster in an undergraduate microeconomics class. Indeed, the blog’s entire analysis is based on comparing Comcast’s fastest tiers with its most popular ones – that is, the ones chosen by consumers based on what they “think they need.”
Tim and I agree on a lot, and I imagine we’ll find more to agree on in the future. Perhaps our next topic could be his contention that “we’re falling behind on residential broadband” when the facts seem to so clearly suggest the opposite.
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