The FTC Should Not Dissuade Personalized Pricing

By Mark Jamison of AEI.

"Imagine that you and I buy the same product from the same website at the same time, yet you pay more than I do. The difference is that the seller knows something about each of us. Perhaps your browsing history, shopping behavior, location, or some other factor suggests that you are willing to pay more than I am. Is this fair? More importantly, is it illegal? 

The Federal Trade Commission (FTC) is thinking about this. This issue is whether there is something about personalized pricing—pricing that treats customers as individuals rather than groups—that increases the chances of unfair or deceptive business practices, as the FTC defines them. It has proposed an enforcement policy that would scrutinize businesses that use personalized pricing. 

The concern is understandable but misplaced. Digitization gives businesses far more information about customers than they previously possessed. And machine learning makes it increasingly possible to use that information to estimate what an individual might be willing to pay. But knowing that prices can be personalized tells us little about whether consumers are harmed. 

The standard textbook example of personalized pricing considers a monopolist that knows precisely what each customer is willing to pay and charges accordingly. The monopolist makes higher profits and higher-end consumers lose the surplus they would have received if prices were uniform. This might sound ominous, but it leaves out much of what happens in actual markets. 

Start with competition. A business that knows you are willing to pay $100 for something might like to charge you $100. But another firm notices and, if feasible, might offer it to you for $90, stealing your business. If firms have similar information about you, personalization can intensify competition for your business. 

This isn’t simply conjecture. Prominent research has shown that personalized pricing can benefit consumers when market coverage is high. It also finds something especially relevant for policymakers: Consumers can sometimes be worse off when only some firms are able to personalize prices than when either all or no firms can do so. Other research reaches related conclusions, finding that consumer information can intensify competition as businesses make targeted offers to defend existing customers and attract customers from rivals. 

There is no general rule that personalized pricing harms consumers or is problematic in any other way. It might benefit firms, but it can also increase competition, bring additional consumers into the market, and improve the matching of products with customers. 

There is another issue that deserves more attention. Many of the analyses assume that the products in question already exist. But we know that when incumbents profit, rivals innovate. The same information that lets a business personalize prices can help it personalize products. This is already happening in e-commerce, entertainment, travel, and education. As the costs of customization decline, both prices and products become increasingly personalized. Regulations that make personalization less profitable will lower incentives to innovate. 

The FTC’s proposal recognizes that personalized pricing is not unlawful in itself. But it states that when consumers reasonably expect prices not to vary with personal data, businesses using personalized pricing should disclose the personalization, its basis, and the types of data used. Failure to do so, the FTC says, is likely to constitute an unfair or deceptive practice. That puts a lot of weight on “reasonable expectations” and the presumed value of disclosing trade secrets. 

People certainly care about fairness. But perceptions of fairness differ among people and change with experience. Americans do not even agree about whether our economic system itself is fair. Trying to turn such perceptions into a policy encourages arbitrary enforcement. 

Besides, consumers already have ways of responding to situations they consider unfair. Richard Thaler’s work on transaction utility shows that people care about more than just prices. They care about the nature of the deal and respond accordingly. Businesses that violate customers’ senses of fairness lose business. 

None of this means businesses should be free to deceive customers. The FTC should pursue violators based on current legal standards, applying them equally regardless of whether prices are uniform, personalized, or something in between. Research gives us little reason to believe that principles should change as knowledge increases." 

Oasis, Ticketmaster and the Price of Economic Ignorance

When supply and demand determine the price of a concert ticket, everybody goes home happy

By Matthew Hennessey of The WSJ. Excerpts:

"Oasis reunion tickets were initially priced at £150, or about $200. This proved far too low. When the online sale went live, Ticketmaster’s “dynamic pricing” system instantly adjusted prices upward. Some ticket buyers reported paying more than £400."

"In economic terms, a concert ticket is no different from a book, a bottle of wine or a house. It has no inherent value, only the price a buyer is willing to pay and a seller is willing to accept. The market-clearing price of anything is where demand meets supply. The correct and fair price is whatever the market will bear. No buyer has a right to a low price, just as no seller has a right to a high price."

‘Price Gouging’ After a Disaster Is Good for the Public

By Don Boudreaux.

"As Hurricane Maria barreled toward Puerto Rico, Sen. Bill Nelson worried that ticket prices for flights out of San Juan and other Caribbean cities would surge. The higher costs would prevent some people from fleeing the storm, the Florida Democrat figured. Using his influence as head of the Senate committee that oversees airlines, he urged major U.S. airlines to cap fares for flights leaving cities in Maria’s path.

Airlines quickly complied. Mr. Nelson’s office declared victory. Economists wept.

That’s because high prices are an essential way to ensure that resources get where they are desperately needed. Imposing artificially low prices creates shortages of vital supplies and makes it harder for people to recover from disasters.

Consider gasoline. In Orlando, Fla., a gallon of regular was selling for as much as $5.99 in the days before Hurricane Irma made landfall, and a 24-pack of bottled water was spotted selling for $99.99 from a third-party vendor on Amazon.

The impulse to denounce the greed reflected in such prices is human. But price hikes are a response to scarcity, and signals that reveal the true severity of scarcity are critical during storms and other crises. Price hikes let consumers know that fuel is scarcer than it was. Price hikes prompt consumers to use fuel more judiciously, buying less gasoline than they would at a lower price. They take fewer unnecessary trips, diminishing pressure on supplies. Price hikes also create a financial incentive for suppliers from outside the area to move their product into high-demand zones. As supplies return to normal, so do prices.

Unfortunately, some politicians can’t restrain themselves from intervening to stop prices from rising. Florida merchants are fined $1,000 for price-gouging during emergencies. Multiple violations in a single day can draw fines as high as $25,000. Members of the House Judiciary Committee recently asked the Federal Trade Commission to investigate “disaster profiteers” who exploited hurricane victims with price gouging.

Yet politicians who suppress prices make it more difficult for storm victims to get much-needed supplies. Artificially low gasoline prices ensure that limited supplies are depleted too quickly, as consumers hoard cheap fuel while they can get it. When price controls on gasoline kicked in with the 1973 OPEC oil embargo, consumers increased the average “reserve” level in their gas tanks. Six years later they began hoarding again when price controls came back after Iran’s 1979 revolution.

The behavior was rational, but only because U.S. policy makers created panic and artificial shortages. During both crises, global oil supply hardly decreased. But Americans wasted hours in long lines and filled their tanks with gas they didn’t necessarily need.

Wasted time has real costs. In 1980 a regulatory quirk forced a handful of California Chevron stations to sell gasoline at below-market prices. Long lines formed, consumers purchased more gas than they otherwise would have, and stations had to ration supplies.

Most of the consumers taking advantage of artificially low prices would have been better off doing just about anything else. In a 1985 study, economists Robert Deacon and Ron Sonstelie concluded that those who waited in line for 15 minutes saved only about $2—less than the average nonsupervisory employee would have earned in a quarter-hour at the time.

History proves that artificially low prices reduce supply, too. As New Year’s revelers in New York City welcomed 2015, Uber’s surge-pricing algorithm stopped working for nearly 30 minutes. Without the guarantee of extra pay, drivers had little incentive to brave New Year’s traffic. Requests spiked 300%, wait times doubled, and the rate of completed trips fell 80%. People who really needed Ubers—and would have been willing to pay surge pricing—couldn’t get a ride.

A similar situation unfolded in Florida last month when JetBlue, Delta and American voluntarily restrained ticket prices on flights out of Florida before the hurricane. By dropping prices during the evacuation, the airlines ensured that flights filled up more quickly, making it harder for many to escape. Some evacuees no doubt booked multiple low-cost flights after prices dropped as a hedge against cancellation. Paying a premium for airline tickets is unpleasant, but letting seats go to waste during an evacuation is tragic.

Price increases are an important means of encouraging as many people as possible to cope as well and as creatively as possible with natural disasters. True, the rising price of goods like gasoline can create problems for consumers, particularly the poor. But these drawbacks are negligible compared to the life-threatening shortages that can result when ill-informed public outrage keeps prices artificially low. Even a poor person is better off being able to buy a bottle of water for $10 when the alternative is to have $10 and go thirsty."

Why Swifties, holidaymakers and the hygienic should cheer for surge pricing

By Tim Harford. Excerpt:

"The basic case for dynamic pricing is simple: it’s the same as the case for the price mechanism in general. In most markets, people are keen to sell when the price is high and buy when the price is low. And at the right price, supply and demand match perfectly.

If the price is either too high or too low, then there are missed opportunities to trade. We might see a queue of eager buyers but shortages of products to buy. 

The most obvious cost of such mismatches is the queue. If I credibly promised to give away £20 to everyone who formed an orderly line in Piccadilly Circus, people would keep joining that line until it was so long that people were being paid £20 to queue for £20 worth of time. I would have achieved the self-defeating miracle of giving away a small fortune without managing to help anybody except the lucky few who joined the queue early.

The same logic applies if I was offering any product or service at £20 below the market price. The time wasted by the queue incinerates the potential value of the bargain, and what the seller loses, the buyer fails to gain.

Of course, not every underpriced product is rationed by queue. Some are rationed by political or social connections. Some are rationed by chance. That is also inefficient. Maybe it’s a rainy night, and everyone would like to get an underpriced taxi home, but only some people also have the option of catching a bus? Those on the bus route are just as likely to get lucky with a passing cab as those who face a five-mile walk in a downpour. If the taxis were more expensive and hence less scarce, those with the choice of catching the bus would be more likely to take it. 

That is the case for the price mechanism in general. But what’s true for prices in general is also true for the price of hotels on the weekend that Taylor Swift is playing a concert in town, of flights on the first day of the school holidays and of toilet paper in the first week of a pandemic. If the price doesn’t adjust, then the result isn’t efficient. Nobody likes to feel that they are being ripped off (so the haters gonna hate) but a sharp increase in the prices of these products would immediately produce the kind of adjustments that any reasonable person would want. If Taylor Swift is playing in Seattle one weekend, it would be a good idea for people who aren’t Swifties to holiday either on a different weekend or in a different city. 

You can tell a similar story about childless holidaymakers, and for people who already have spare toilet paper but might as well pick up more just in case. We are outraged that the price increase squeezes more money out of people who are keen on Taylor Swift, a late July getaway or a clean bottom. We tend not to realise that the price surge gently encourages those who can make alternative arrangements to do just that.

Little rides on the nothingburger question of whether Wendy’s might vary the price of junk food. But if more supermarkets used digital labels to vary the price of food, shifting food near its sell-by-date and warding off shortages of hotly demanded produce, the world would be a less wasteful place.

And there is a market in which the fate of the planet turns on dynamic pricing, namely electricity.  Electricity demand varies a great deal depending on the weather and the time of day, and increasingly electricity supply also fluctuates depending on the sun and the wind. The cost of offering customers a static price for electricity is enormous: it requires huge overcapacity in general, and overcapacity of fossil fuel plants in particular, because gas turbines are well suited to coping with brief spikes in demand.

Part of the solution is obvious: encouraging electricity users or their smart devices to draw less power at peak times, and batteries or other forms of energy storage. The basic way to fund storage? Allow the battery to buy electricity when it’s cheap and sell it back to the grid when it’s expensive. All this is much easier with dynamic pricing. We have a planet to save, after all."