Should Stores Charge Different Prices for Different Size Clothes?
Matthew Martin 1/17/2013 02:28:00 PM
Now lets think about competition. Suppose a firm, like Express, charges the marginal cost of the large shirt as the price for all sizes. This means that a competitor could make the same shirt, but producing only the small and medium sizes, and sell them for a bit less than what Express is charging for them. In perfect competition, that means that (except for some search frictions) all buyers of small and medium shirts should abandon Express and buy the shirt for a little bit less at the competitor. Express can respond by either halting production of small and medium shirts--that is, specializing on large sizes--or by cutting their prices on small and medium shirts as well, which they can do profitably because we have not assumed that their production technology is any different than their competitors'.
This says that even though the small and large shirt are of equal value to consumers, we should still see differing prices due to the differences in production costs. Now, you can argue that clothing stores aren't examples of perfect competition--the shirts made by competitors will inevitably differ from those made by Express in ways that consumers care about, so that each store is selling clothing that is largely substitutable, but slightly different. This is monopolistic competition. We have some decent models of this kind of monopolistic competition, and it turns out that this distinction changes very little--profit maximizing firms will charge a markup over marginal costs, but that markup is a constant. That means that even with monopolistic competition we should see different prices for different sizes.
So why is it that Express can get away with charging the same price for all sizes?
One possibility is that Express is not maximizing profits along this dimension. In perfect competition, this means that Express would be driven out of the market for at least some sizes. But in monopolistic competition, firm profits are positive, meaning that Express might be able to set its prices for the medium and large equal to its price for the small, and still earn a positive amount of profits overall. This is not profit maximizing, since they could have charged more to the medium and large size people--who presumably are unable to substitute for smaller clothes.
Another possibility is that perhaps there are frictions I have not considered. I have no idea how much extra cloth it takes to make a large shirt than a small, but it is possible that this is quite small, so that fictions associated with keeping different prices--such as producing extra bar codes and labels for the products--are actually larger than the cost of the additional cloth. Or maybe it actually doesn't take more cloth to make a large size than a small--there is a fair amount of waste cloth in the production of any garment, and it may well be the case that in the most efficient method of production the only difference between a large and small is the amount of waste. In that case, marginal cost is not affected by size.
Another, less likely, possibility is that elasticities of demand differ between buyers of large and small clothing. This is unlikely in the sense that it would be an extraordinary coincidence if the elasticities happened to exactly counteract the effect of differing marginal costs. But the premise is quite reasonable--buyers of large shirts are always buyers of large shirts, so that if large shirts cost more than small shirts, this makes the large person poorer than the small person, and therefore more price elastic, which would in turn place downward pressure on the prices of large shirts relative to small ones.
One final hypothesis, which is the one I hear most often when I pose this question (I will pose it in a slightly more technical manner than I usually hear it): maybe that form of price discrimination imposes non-market costs on firms. What I mean by this is that consumers might find that form of price discrimination distasteful and choose not to shop at stores that do it. This is a non-market force in the sense that it requires collective action that is coordinated by some means other than the price system itself--mechanisms such as social norms and cultural values, for example.