The Pros and Cons of Price Discrimination

This article provides a review of the economics literature on oligopoly price discrimination by purchase history. Two basic models of repeated purchases with two firms and two periods are discussed in detail, one in which firms produce a homogenous good ex ante but where there is ex post product differentiation due to consumer switching costs, and another in which firms’ products are differentiated because consumers have intrinsic differences in their brand preferences. Price discrimination based on purchase history arises as equilibrium pricing strategies by competing firms, and such a practice tends to lower industry profits but may or may not benefit consumers. From a welfare point-of-view, there is too much consumer switching between firms. These results extend to models with multiple firms and multiple periods. Further discussions are provided on the effects of long-term contracts and other loyalty-inducing arrangements, on marketing innovations and the legal protection of consumer privacy that affect firms’ ability to gather consumer information, and on the antitrust implications of purchase-history based price discrimination. ∗ I thank Marc Armstrong and Mats Bergman for helpful discussions and suggestions. Any remaining error is my own responsibility. ∗∗ Department of Economics, University of Colorado at Boulder, Boulder, CO 80309, USA. Phone: (303)492-8736; E-mail: [email protected].