Sunday, 31 January 2016

Why are women charged more than men?

Evidence (albeit somewhat anecdotal) suggests than women are being asked to pay considerably more than men for almost identical consumer products. This seems to apply to clothing, toiletries, toys, even pens. Why? It is hard to believe that it costs more to produce products for women than men. So, I think we can safely discount the idea that the difference is being driven by costs. The far more likely explanation is price discrimination.
      To illustrate consider a very simple example. Imagine you are the owner of a company making jeans. It costs £25 to produce a pair of jeans and you are currently selling them at £50 a pair. At this price you sell 100 a week to men and 50 a week to women. The key question you have to consider is what would happen to sales if you increase (or decrease) the price? Suppose that at a price of £55 a pair you estimate you would sell 80 to men and 45 to women. On the male side this is a bad deal because profit falls from (50 - 25)(100) = £2,500 to (55 - 25)(80) = £2400. But on the female side you do well because profits increase from £1,250 to £1,350.
       In this example it clearly pays to charge women a higher price than men. But note that this is because women are less sensitive to price than men. This is different to saying that 'women are willing to pay more than men'. After all, you were selling less jeans to women than men. Generalizing from this example, optimal pricing is always driven by how sensitive a market will be to changes in prices. So, if firms are charging lower prices to men it would seem that men are more likely to react to price than women. This, though, is not the end of the story.
       The story so far is one of 3rd degree price discrimination - different categories of consumer (namely male and female) are being charged a different price for an identical product. Textbooks will tell you that 3rd degree price discrimination can only succeed if there is no potential for arbitrage. In other words it must not be possible for women to buy from the male market. There appears, however, little to stop that happening. This suggests, therefore, that women, as well as being less sensitive to price, are also reluctant to shop around.
         Arbitrage, though, is not just about buyers' willingness to shop around because someone else could do the shopping around for them. If, for instance, identical products sell for £5 in one location and £10 in another an enterprising individual can buy the product at £5 and sell it for £8 at the other location. There is simple money to be made. That this has not happened would suggest the firms involved have significant market power. Enough market power that no one can steal their market. This is unlikely to change any time soon.
        But, the recent news may lead to more women shopping down the male aisle of supermarkets. Ultimately arbitrage should win through and lower the price gap between male and female products. Unless, that is, the price differential is actually being driven by something different. If, for instance, the products compared are not actually identical, and a pink pen is not really identical to a blue one, the price differential can persist. So, don't expect arbitrage to eliminate all of the gap between male and female prices.             

Tuesday, 5 January 2016

What is (not) wrong with high rail fares in the UK?

On Saturday rail fares in the UK rose by an average of 1.1%. This is the latest instalment in a long running trend of fair increases. Indeed, average fares have risen by around 40% over the last decade. As usual passengers were queuing up to say how disgraceful it all is. This year the opposition leader Jeremy Corbyn joined the fray with his standard call for a renationalisation of the railways. But what is the problem with high rail fares?
       The main reason I ask this question is one of revealed preference. At the same time as complaining about high fares, most passengers also complain about having to stand on over-crowded trains. Indeed, use of the railway has soared, with over 70% more journeys now than in 2002. Moreover, I don't think that anyone would seriously dispute that the UK rail network has just about reached the limit of its capacity in terms of the number of trains operating.
        If a price rise is accompanied by a reduction in demand then we can start to think about firms exploiting a monopoly position to extract high profits. But, when a price rise is accompanied by an increase in demand then the only logical conclusion is that there is excess demand. And if supply, in the short term, is fixed by the extent of the railway network then there is a strong argument that prices are not high enough.
        Put simply, if passengers continue to use the railways at higher prices then they reveal that prices are not too high. The response to this would no doubt be that passengers have no choice to use the railway. But that is not true. Passengers can change where they live, change job, change the time they commute etc. Furthermore, enterprising soles could no doubt come up to alternatives to high rail fares such as companies that allow working at home or have office hours that can exploit off-peak fares. From an economists perspective, passengers choose to pay the high fares.
        Another objection to high fares is that it disadvantages the poor. This argument, though, does not stand up to any kind of scrutiny. The main users of the rail network are the relatively well off, not the poor. Also, despite high fares, the rail network is heavily subsidised by the taxpayer. To lower fares would require an inevitable increase in taxpayer subsidy and would, most likely, be a regressive policy that benefits the relatively well off. (A recent article in the Economist touches on these issues.)
          If high rail fares are neither inefficient, nor inequitable, what is the problem? Suppose you spend £50 for a ticket on a commuter train and then have to stand up the whole journey. The economics textbook tells you that you reaction is supposed to be: I wish the fare had been £100 because then less people would have turned up and I would have got a seat. The common reaction, however, is presumably something like: when I pay £50 I expect a decent service and standing-up is not good enough. It just seems plain unfair to pay so much for a poor quality product. In a seminal article published in 1986 entitled 'Fairness as a constraint on profit seeking', Daniel Kahneman, Jack Knetsch and Richard Thaler show that people particularly dislike price increases that are due to shifts in demand. The outrage at rail fare increases seems to fit that picture.
        So, what could we do? Lowering fares might make people feel less exploited but would only exasperate excess demand. So, this is not the solution. Increasing supply would help but is only a long run possibility. Another option is to push fares higher but put a headline grabbing tax on the rail companies. Then, at least, passengers would not feel exploited. The train operating companies, though, do not make particularly high profits and squeezing these further is unlikely to increase the quality of rail services. Which brings us finally to renationalisation. If this is to lower fares then the taxpayer will have to pay the difference. And as I have argued this benefits the rich at the expense of the poor, which hardly seems desirable. The status-quo, therefore, seems not so bad.