The Dysneland case
Disneyland, located in Anaheim, California, attracts approximately 15 million visitors per year, making it
second only to Disney World in Florida among the world’s most popular theme parks. Disney employs many
of the techniques that we will analyze in this chapter to capture more surplus from its customers, including
price discrimination, bundling, and advertising. The simplest entry pass to Disneyland is the 1-day ticket,
priced at $72 as of March 2010.2 However, Disney offers a variety of prices tailored to the different types of
visitors. Customers between 3 and 9 years of age pay only $62 for the 1-day ticket. Residents of Southern
California are eligible for discounts, as are members of the American Automobile Association. As this was
written, Disney was offering $40 discounts to those who purchased their tickets online at Disney’s website.
Group rates are available with lower prices per person. These are examples of third-degree price
discrimination, with different types of customers being charged different prices for entry into the park.
Disney also offers quantity discounts, a form of second-degree price discrimination. It is possible to purchase
tickets that allow entry into the park for differing lengths of time, ranging from 2 days to 6 days. The more
days allowed on the pass, the lower is the per-day cost of the ticket. Disney also sells an annual pass with a
“Deluxe” option that can be used 315 days of the year, but precludes entry on selected very popular days.
Consumers can purchase a “Premium” option that can be used whenever the park is open. You may also
purchase tickets that bundle entry to Disneyland with other goods. One example is the “1 Day Park Hopper”
ticket, which allows you to visit both Disneyland and the adjacent Disney’s California Adventures Park. A
standard ticket to either would cost $72, but the Hopper ticket costs only $97 ($87 for those age 3–9), far
less than the price of two standard tickets. In addition, discounted entry to either park is available if you stay
at the Disneyland Resort Hotel, or if you purchase selected vacation packages offered by travel agents. In the
past Disney employed other pricing strategies. From its opening in 1955 until 1982, Disney charged customers
a relatively low flat fee to enter the park and then required visitors to buy individual tickets for each ride. The
price it charged for a ride depended on the popularity and excitement of the ride. Its tickets ranged from the
least expensive A rides to the most expensive E rides. In fact, the colloquial term an E ticket used to describe
the best of something stems from this system of pricing.
Education
A college education in the United States can be expensive. Tuition costs more than $150,000 for four years
at many private colleges and universities, and often more than $60,000 at state-supported colleges. Colleges
are naturally concerned about whether families of prospective students can afford such large expenses. Some
types of financial aid are based on merit, recognizing a student’s academic performance. More often, at the
undergraduate level, financial aid is based on a family’s financial need. The amount a student’s family will be
required to contribute toward college expenses will be based on how much money the family has saved and
expects to earn, how much the college estimates that the student can afford in student loans, as well as the
cost of the education at a particular institution. How do colleges determine how much you should be willing
to pay for a college education? Before being considered for many types of aid, students must supply
information about their family finances on forms such as the Free Application for Federal Student Aid
(FAFSA). Colleges then use a government-sponsored formula to calculate the amount the family is expected
to contribute toward college expenses. This is called the Expected Family Contribution (EFC). If the EFC is
equal to or more than the cost at a particular college, then the student will probably be ineligible for much
financial aid. However, if the projected cost of an education at a college exceeds the EFC, then the student
will probably qualify for assistance, maybe even enough to meet the full costs. In 1991 the U.S. Department
of Justice filed a lawsuit against universities in the Ivy League and the Massachusetts Institute of Technology,
alleging a conspiracy to fix “prices”—student aid—in violation of the Sherman Act1. In the late 1980s over 20
colleges held annual meetings to discuss aid offers that they would be making to their current and newly
admitted students. The Justice Department argued that this cooperation served to reduce competition for
students. The Ivy League schools signed a consent decree to stop the meetings, but MIT refused to sign and
took the case to trial. MIT argued that financial aid was a “gift” to students and that, as a nonprofit it was not
subject to the Sherman Act. In 1992 MIT lost the case. However, Congress soon passed the Higher Education
Act of 1992, legalizing much of the conduct in question. In 1993, MIT won a reversal of the court decision on
appeal, at which point the Justice Department settled. Colleges are now allowed to engage in most of the
conduct that had been in contention during the trial. Princeton University made news in 2001 when it
announced a new “no loan” financial aid policy. All financial aid decisions at Princeton since that year have
been made with the assumption that no Princeton student will be expected to take out any student loans to
pay for college. Instead of student loans, Princeton now gives grants of equivalent value to all students whose
financial situation requires them. The average student at a four-year college borrows about $15,000 over
four-years, so Princeton’s policy is quite generous compared to that of its competitors. Princeton stated that
its goal was to increase enrollment of low- and middle-income students, and that the program has been
successful in doing so. A few other colleges (like Williams and Dartmouth) had adopted a “no loan” policy in
recent years; however, after university endowments plummeted during the Great Recession of 2008–2009,
they reinstituted loans for some students. When colleges base the amount of financial aid they give you on
your ability to pay, they are engaging in first-degree price discrimination. Although no college is a monopolist,
each knows that the demand for the education it offers is downward sloping. The number of students who
would like to attend a college rises as the price the college charges (for room, board, and tuition, less any
financial aid) fall. To price discriminate, colleges must have information on willingness to pay. Although
colleges may not be able to get an exact measure of the amount a family will be willing to expend, that
amount is probably highly related to the calculated EFC. Finally, colleges don’t have to worry about “resale”
because you cannot sell your college education to someone else.
Block price in electricity
When a power company sells electricity with a block tariff, it does not know each individual’s demand
schedule. However, it does know that some customers have larger demands for electricity than others. It
also knows that each consumer’s demand curve is down ward sloping, so that a lower price will stimulate
that consumer to purchase more electricity. Suppose the market has two customers, Mr. Large and Mr. Small,
with the demand curves shown in Figure. If the company charges a uniform price P1 for all units of electricity
sold, Mr. Small will buy Q1S units of electricity per month, and Mr. Large will purchase Q1L units. But suppose
the company introduces a block tariff, charging P1 per unit for the first Q1L units purchased and a lower price
P2 per unit for any additional units. How will the block pricing affect Mr. Small, Mr. Large, and the electric
power company? Mr. Small’s purchases are unchanged because he does not purchase enough electricity to
take advantage of the lower block price P2. He still buys Q1S units at a price P1, and his consumer surplus is
therefore the same as it was under the uniform pricing system. Mr. Large, however, will expand his
consumption of electricity from Q1L to Q2L units, increasing his consumer surplus by area I. And the company
will be better off because its producer surplus will increase by area II. This example illustrates an important
potential benefit of block tariffs. If we start with a uniform price that is different from marginal cost, then
1
Gustavo Bamberger and Dennis Carlton, “Antitrust & Higher Education: MIT Financial Aid (1993),” in John Kwoka and
Lawrence White, The Antitrust Revolution: Economics, Competition, and Policy, New York: Oxford University Press,
2003.
introducing a block tariff leads to a Pareto superior allocation of resources. A Pareto superior allocation of
resources makes at least one participant in the market better off and no one else worse off2
Air transport
Airlines typically sell tickets at a variety of fares, as we saw at the beginning of the chapter when we looked
at American Airlines’ flights between Chicago and Brussels. Third-degree price discrimination in one of the
strategies airlines use to fill the plane with travelers in the most profitable way. Airlines often charge
different prices for seats in the same class of service, such as coach class, even though the marginal cost of
serving a passenger is about the same for all passengers. Different customers are willing to pay different
amounts for tickets. For example, people traveling on vacation often can book their tickets weeks or even
months in advance of the flight, and they are willing to shop around for the best price. They may even
decide to choose their destinations based on the availability of relatively inexpensive tickets. Thus, vacation
travelers are usually quite sensitive to price, especially if the vacation involves the whole family. In contrast,
passengers traveling on business are often less sensitive to the price of the ticket. When business requires
that a passenger be in London for an important meeting on Monday at 8:00 AM, the traveler will make the
trip even if the fare is expensive. An airline knows that it serves different types of customers, including
business customers with a typically relatively inelastic demand, and vacation travelers with relatively elastic
demand. Since the marginal costs of service are similar, the inverse elasticity rule suggests that an airline
would like to charge a higher price for business travelers. How does the airline implement price
discrimination? Although it knows that there are different types of travelers, it does not know the specific
type of any customer. It could ask the customer to reveal his or her type with a direct question, “Are you
traveling on business or pleasure?” But if travelers knew they would be quoted a lower price by identifying
themselves as vacation travelers, the response would often not be truthful. Economists say that
information is asymmetric: The customer knows his or her type, but the airline does not. How does the
airline design a mechanism to implement price discrimination in the face of the informational asymmetry?
It builds a set of fences. Restrictions on fares are ways of “degrading” or “damaging” product quality. A
2
For more on this topic, see R. D. Willig, “Pareto Superior Nonlinear Outlay Schedules,” Bell Journal of Economics 9
(1978): 56–69. With respect to the market for electricity, the argument for the Pareto superiority of nonlinear outlay
schedules is clearest when the consumers are end users of electricity (e.g., households). The argument is a bit more
complex when the purchasers of electricity are firms that compete with one another in some market. One of the
complications arises because quantity discounts from block pricing could conceivably allow a larger, less efficient firm
to produce with lower costs than a smaller, more efficient firm, because the larger firm can purchase electricity at a
lower average price. Pareto superiority is named for the Italian economist Vilfredo Pareto (1848–1923).
nonrefundable fare is of lower quality than a refundable fare. A fare that requires that you to pay for
checked baggage is also of lower quality. So are fares that require you to stay over a Saturday night or to
purchase the ticket 14 days in advance. In building fences, the airline is creating different versions of its
product, with low-quality, low-price tickets that appeal to price-sensitive customers, and high-quality,
highprice tickets that appeal to less price-sensitive customers. Customers are then induced to self-select
into the product type designed for them.