Case of the Day: Price Discrimination in Higher Education
Perhaps the most commonly cited example of price discrimination is airlines, which currently charge widely varying prices to customers on the same flight depending on when the flight was booked, whether it is part of a round-trip booking, how long the passenger is staying at his or her destination before the return flight, and other factors. There may be passengers who paid a dozen or more different prices all cohabiting the same airplane.
The same is true of the students in this class: financial-aid policies of Reed and (even more so) other colleges result in students being charged many, many different price levels for the same educational services. (But unlike the airlines, we don't offer free luggage or better food to those in the "expensive seats.") Reed's financial-aid policies offer aid (which can be thought of as discount pricing) to students based solely on their measured "financial need," which an economist might call "ability to pay."
There are elements of Reed's financial-aid policy that are similar to monopoly price discrimination, but there are also ways in which it is different. The questions below ask you to think about these similarities and differences.
1. What is Reed's "objective function" and how does it compare to that of a traditional monopoly firm? (In other words, what is Reed trying to maximize?) Does this lead to a difference between Reed and the traditional monopoly in the motivation to price discriminate?
2. According to standard monopoly theory (as in the textbook), what market and demand characteristics are necessary for price discrimination to be successful? Does Reed's market have these characteristics? Could Reed undertake perfect (first-degree) price discrimination?
3. How does a perfect price-discriminating monopoly choose the price to be offered to each customer? How does Reed choose the net tuition level (price) to be offered to each student? Are they the same or are there important differences?
4. How would your answer to the previous problem be different for a college such as Grinnell, which offers extensive "merit aid" that is not based on need to academically desirable students?