Price Discrimination: The Case of Middle East Autocrats Buying Friends

I have read that both Libya and Saudi Arabia are offering cash to “loyal” subjects.  In Libya, $400 is to be given to each family and Saudi Arabia has budgeted $35 billion to be given which  works out to roughly $2,000 per person.    Now, the Beatles told us that money can’t buy you love.    Should the self interested leaders focus their transfer efforts on the young men?   If the old and the women have more bread, does this buy the peace?    The economics of price discrimination tells us that you don’t offer a coupon to people who always buy the product or will never buy the product — you focus your incentives efforts on those “at the margin”.  In the case of the nascent revolution,  do the leaders of these nations have incentives to “transfer discriminate” and focus their payoffs on demographic subgroups?    With a fixed pot of $,  targeting subgroups of the population would allow the leaders to make nicer offers.

Author: Matthew E. Kahn

Professor of Economics at UCLA.

13 thoughts on “Price Discrimination: The Case of Middle East Autocrats Buying Friends”

  1. “The economics of price discrimination tells us that you don’t offer a coupon to people who always buy the product or will never buy the product — you focus your incentives efforts on those “at the margin”.”

    On the other the PSYCHOLOGY of human behavior tells us that converting transactions that used to be performed based on common norms or internal incentives into cash-based transactions frequently has very deleterious consequences — vide fining parents who pick up their children late from daycare in Israel, offering to buy off people affected by a new garbage dump in Switzerland, paying children to do their schoolwork in the US…

    I hate to be that guy, but SERIOUSLY!
    This is an extraordinarily important issue, and once again we see the mindless arrogance of economists. Ignorant of history, politics, psychology and sociology, but convinced that they alone hold the key to human behavior, we get facile ideas that are so foolish a child could see why they are bad. Ever heard of the concept of “resentment”? Ever seen how the Ultimatum game plays out in real life?
    And yet these are the people that, because the profession as a whole is so willing to prostitute itself, have half our country in thrall, offering up one inane idea after another, from regulation-free big finance to drastically cutting the R&D budget of the entire US in spite of all the evidence of the good it has done.

  2. This is a horrible idea, made worse by your support of it. The protesters want rights, not money and anyone who accepts money to turn quiet will be seen as Judas. Maynard is right about economists: ideas ranging from ignorant to abhorrent.

  3. This is a disturbing example of the nihilism that masquerades as so much ‘social’ science these days.

    What, I wonder, is your price for supporting a would be dictator? And what would you think of an economist who advised him how better to cement his power?

    Is everything simply a game of manipulation, with the most efficient manipulator the winner?

  4. Harper’s had a similar thesis some years ago and made a cover story out of it: “Let Them Eat Fat. It is a different type of acquiescence or passivity and not direct like Matt posits, but still.

  5. I’m surprised at the hostile reaction this piece received. I think this would be a great way for Groupon to get off the ground in Tripoli or Manama. 15 dinars for 30 dinars of baksheesh. 40 rials for a 6-week vacation in Tahiti (must be male, unemployed, disaffected and leave within 24 hours). It’d be a win-win-win.

  6. Maynard has supplied the relevant rant, re: Imperial Economics.

    Fairly obviously, the Saudi government has long made a practice of targeting the Saudi family itself for the benefits of being the governors governing; its a family firm, after all.

    I was going to point out, far more mildly, that Professor Kahn apparently does not understand the economics of price discrimination, but I wasn’t sure what the analogy to Saudi politics would be, or should be.

    MK: “The economics of price discrimination tells us that you don’t offer a coupon to people who always buy the product or will never buy the product — you focus your incentives efforts on those “at the margin”.”

    This statement, as a matter of economics, is simply wrong. If you are offering a coupon to those “at the margin” — which happens, it’s just not price discrimination — you may be engaged in demand management, not price discrimination, or perhaps, you are engaged in marketing research, trying to gain information about price elasticity. “Price discrimination” schemes, contra Professor Kahn, by definition, focus not “at the margin”, but inframarginally. The whole point of price discrimination is to capture inframarginal consumer surplus. The firm wants to find ways to charge at least some of those who most value their goods, a higher price. So, inframarginal, not marginal.

    It’s a bit of fooler, coupons and their evil cousin, the mail-in rebate. To some extent, of course, you are taking advantage of people, who have more money than time-to-clip-coupons or mail-in-for-rebates. Another analysis, though — and one with potential relevance to the politics of hereditary, authoritarian governance — is that you are providing a pseudo-activity to preoccupy those most motivated to pursue “competitive” activities that might undermine your position; in other words, you are giving buyers, who would be most likely to search and substitute, an alternative path less destructive to your interests. In that respect, the dollar value of the coupon is less strategically relevant than the distractive effect of the associated buyer behaviors.

    Price discrimination — though it exploits an opportunity on the demand side to capture consumer surplus for the producers — is motivated, not so much by the demand-side opportunities, as by the imperatives of production cost. Often, in reality, though not so often in economist’s textbook models — firms have a production process that exhibits increasing returns to scale over the relevant range of rates of production. Even where technology does not dictate increasing returns due to network effects or increasing scale, sunk cost investments and committment to overhead expenses means that firms, typically, would like to sell additional units at the current market price.

    This is not the situation contemplated by the classic textbook model, in which the firm limits its output at the point, where its marginal revenue equals marginal cost. In the classic textbook model, the firm’s marginal cost is rising. In real life, marginal cost is usually constant or falling.

    When marginal cost is falling over the firm’s relevant range of output, the firm has strong incentives to price discriminate. Charging a single price, at or above average cost, foregoes the opportunity to reduce average cost by expanding output. It may be that contemplating this situation led to Professor Kahn’s confusion about the nature of price discrimination and its focus. But, the problem isn’t finding people, who will buy at a lower price; the problem isn’t even keeping (at least some of) the people, who value the product most highly, from buying it at the lower price.

    Though the tactics of price differentiation may seem to turn on finding and segregating consumer “demographics”, the deeper, strategic problem may actually be on the producer’s side, the side of cost structure and competition: finding ways to credibly commit to a price that is divorced from the cost of production. The seller has every incentive to try to sell more at the current price, and the possibility of selling a lot more at a slightly lower price beckons constantly, like the legendary siren. And, competitors have an incentive to uncut. If you expand the scope of your strategic understanding of “competitor” to include the buyers of your product, then you realize that, not only may rival producers want to undercut, but high-surplus-value consumers also have a large latent potential incentive to use search, substitution or their-own-production to undercut you.

    This strategic problem does not exist for the firm of the textbook, where marginal cost is rising over the relevant range of output. That firm isn’t much tempted to expand output beyond the point at which its marginal cost of output exceeds its marginal revenue, nor does it have to do much to convince rival firms or buyers (familiar in outline with that cost structure) that it will not violate that “rule” of behavior. But, for actual firms, with declining marginal cost, the firm may have serious trouble even convincing itself to follow any rule of behavior, which doesn’t drive price below average cost, threatening ruin.

    Now, the firms we actually observe, persisting in the world, have mostly solved this problem successfully — at least, for the moment — so, it would be easy to underestimate how strategically problematic, a cost structure featuring sunk cost committments and declining marginal unit cost of output is likely to be. Many of the stable solutions depend on some politically enacted or legitimated rule — utility and transportation economic regulation often mandates some system of structured price discrimination. (Note to moronic libertarians: this does not mean that such regulation is evil or wrong.)

    What the analogy might be to political governance by a kleptocracy, I’m not entirely sure.

    We might imagine that the state is a firm with a (near-)monopoly on violence, producing and distributing violence as a monopolized intermediate in the production of public goods.

    As a monopoly, is the state following the classic model of a firm with rising marginal cost, of restricting output of violence, in order to realize a higher price for the limited output of public goods?

    Is the state concentrating surplus value in the hands of a small class, as a way of creating a reliable and motivated group of supporters, which can coordinate to support the state?

    I’m lost.

  7. Bernard Yomtov says:
    February 26, 2011 at 10:17 am

    “I think maybe Matthew is just sort of ruminating, not seriously suggesting this as policy.”

    There is no such thing as an economist ‘just sort of ruminating’.

  8. Libya and Saudi Arabia are getting their bribe-the-peasants money from their oil revenue. A rational citizen would recognize that if the regimes ruling those countries are overthrown, the successor government will have access to the same stream of oil revenue. Therefore, the current government should only offer this, loyalty incentive to people who are likely to be worse off in post-Qadaffi Libya or post-monarchy Saudi Arabia. And aren’t people like that already compensated quite handsomely?

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