Heterogeneity in Price Sensitivity and Retail Price Discrimination

Abstract

The nature of heterogeneity in price sensitivity has considerable implications for research in the study of retail price formation. New data collection technologies have become available that allow firms to gather detailed information on household demographics and purchase histories. Using these new methods, it is increasingly feasible for a firm to perform demand estimation at the demographic group or even the household level. With household demand estimates in hand, a firm can offer individualized discounts, engaging in nearperfect price discrimination. The nature of heterogeneity in household price response has implications for how firms might be able to extract surplus from consumers through individualized pricing. Price discrimination has long held the interest of economists interested in the pricing of retail food products. The types of price discrimination traditionally discussed in food retailing are secondand third-degree price discrimination. Second-degree price discrimination involves self-selection on the part of consumers, where sellers offer price/quantity or price/quality bundles designed to attract different consumer types. Well-known examples of second-degree price discrimination are quantity discounts or coupons issued in newspaper supplements, magazines, or mass mailings. Third-degree price discrimination arises when retailers charge different prices to different market segments according to the demand elasticity of each segment. For example, retailers might charge different prices at different retail outlets or offer discounts to identifiable groups, such as students or senior citizens.