Apple iPad

A typical example of price discrimination is student pricing to see a movie.  Cinemas aren’t giving a discount to students because of any sense of charity – they do so because it’s a crude way to identify people with lower incomes and sell them tickets they otherwise wouldn’t buy.

The iPad makes a great example for price discrimination because the models are so similar.  The hardware is identical, except for two options – storage capacity, and 3G data network capacity.  The pricing – in Australian dollars at the time of writing – is below.

This price model can be expressed another way – as the base price plus the price of the only two things that can change:

The price jumps are pretty much consistent.  You pay $130 to move from 16 GB to 32GB, and another $120 to move to 64GB.  And you always pay an extra $170 for 3G data network capability.  But these components cost nothing at all like these amounts for Apple (even once currency conversions are taken into account).  The 3G capacity costs Apple about US$25, and the three storage options cost about US$30, US$60 and US$118 respectively.   Price discrimination is a key reason why Apple’s pricing is so out of line with its costs[1]}.If a potential buyer doesn’t have a high disposable income, but wants[2] an iPad, she can settle for the cheapest model, and manage storage needs by swapping in and out the data she needs.  Books take up little space, after all, so with a little planning, 16GB is adequate for most uses to which an iPad would be put.  If this user wants to be able to access a 3G network, she’s going to have to pay for the privilege.  It’s assumed that she’s a little better off, as she will have data network charges to pay.  The reasoning would be that if she can pay for the network traffic, well, she can also afford to pay a little more for the iPad as well.  A similar argument holds for storage.  If you are the sort of person who wants 64 GB of storage on a portable device, you’re probably using it to store films which (in theory, at least) you paid for.  Given that a digital copy of a feature film weighs in at 1.5 to 2 GB, that’s a fair few films.  If you can pay for the films, then you can pay for the 64 GB iPad.

So the variable pricing is a neat way for Apple to identify its customers who are willing to give it more money, which is one of the key conditions that allows a firm to price discriminate[3].  It really serves little other purpose.  Apple could easily have released all iPads with 64 GB, and only varied between 3G and no 3G (or, given that the 3G capacity costs it US$25, just released all of them with 3G).  If they had, even at the price of the Wi-Fi + 3G 32 GB model ($928), they’d be losing sales from people who might have had $630, but not $930 (so generating zero revenue) and also not generating the extra revenue from people who were willing to pay at least $1,049.

A final note.  Apple probably could have charged more for the 3G versions, at least on release.  They’ve sold out very quickly, at least in Melbourne.  There’s significant unmet demand and a shortfall in supply, which is a pretty good indicator that the in short term at least, the equilibrium price is higher than Apple has charged.

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FOOTNOTES
1. Another key reason is to allow for rationing of components, which may be the subject of a later post one day.↑
2. No-one, anywhere, needs an iPad.↑
3. The others are that the firm needs some form of market power, which Apple has (if you want an iPad, you buy it from Apple), and either the capacity to vary the goods (like the different capabilities on the iPads) or the ability to prevent resales (like selling your student movie ticket to a person who would otherwise have to pay full price).↑

Fixed price purchasing

Firstly, consider a Metcard.  Let’s think about a zone 1, ten trip, two hour ticket.  In 2008, such a Metcard would cost $28.00.  In 2009, the price increased to $29.40.  This represented a 1.05% price increase – lower than CPI.  But Metcard tickets, once bought, entitle the buyer to their trip – in this case, ten zone 1 trips.  The value of your purchase is not diminished over time.  A Metcard does not store value – it stores journeys paid for in advance, with a set charge at the time of payment.

Diminishing value to the traveller

A Metcard holds its value fixed.  Myki does not.  Going by current prices, let’s consider a balance of $100 on a Myki in December 2008, as opposed to $100 worth of ten trip Metcards.  Myki is bright enough to give the same discount for buying ten trips at a time.  This gets you 35.7 trips on a Metcard or on a Myki.  In January 2009, the price increases.  Your Metcard still gets you or 35.7 trips.  Your Myki now only gives you 34 trips.  This represents a 1.05% decline in value for the traveller in the space of a month.  This will be endemic, even if smaller price increases are introduced more frequently, the number of trips a given value of money allows diminishes over time with Myki in a way that it does not with a Metcard.

Buy in bulk and save

What’s been done correctly is that the price for a two hour zone 1 trip with a Myki is $2.94 – the same cost as a ten trip Metcard.  On the assumption that prices standardise on the bulk purchase rate, this leaves a consumer who buys in bulk no worse off with Metcard or Myki.  While Myki has a fixed cost of $10 to buy, this cost can be split over the cost of every trip made throughout the life of that card.  If you lose cards frequently, you’ll pay for it, but if you don’t, the cost per trip of the purchase of your card rapidly approaches zero.  And travellers who frequently buy their tickets on the tram or bus, or who don’t usually buy in bulk will benefit from Myki’s charging regime[1].

An interest free loan

Using Myki, you don’t buy trips, but rather you store value.  You could think of it like a savings account that pays no interest, and the money in it can only be used for one thing.  It’s a store credit, if you will.  The key difference here is that when public transport costs increase, the value in your Myki in no way will reflect this, whereas the value of a Metcard does.  A 3% rise in fares coupled with a 3% increase in the cost of living is cancelled out with a Metcard (roughly – see the forthcoming page on indifference curves and CPI).  A 3% rise in fares with Myki represents decrease in the value of stored money (as seen above).  But that stored money also represents an opportunity cost for the Myki account holder and a bonus for the State Government[2].  Let’s consider 500,000 Myki holders (roughly an eighth of Melbourne’s population in 2010), each with a balance of $20.  This gives $1,000,0000 in credit.  Invested at 5%/annum, this returns $50,000 in profit.  So at the same time as the value stored in your Myki (as measured in trips) is declining, your money able to be used to get investment returns for someone else.  You’re caught coming and going[3].

Returning the value

The two flaws above are by design.  They’re part of the point of the system.  They tilt the field slightly against public transport travellers and in favour of the State Government.  Over the lifetime of Myki, this tilt may represent a reasonably significant amount of money.  Designing the system to accommodate this would be simple.

One way – which would not work – would be to not increase fares again.  This gets around the first problem, but not the second.  And it creates a new one.  Fare income is (I hope) put back into the system.  The real cost of no fee increases in an inflationary environment would, over time, approach zero.  A zero fare public transport system will still cost the state money, and would represent a transfer of wealth from areas without public transport to areas with it.  I’ve a feeling that areas without public transport are already generally less well off than areas with it, so a close to zero fare approach is probably regressive.

A way to ameliorate both problems above can be implemented with two steps.  Keep fare increases (only at a reasonable level), but increase the value stored on a Myki at the same time, to the same proportion as an increase.  If fares increase by a flat 2% across the board, increase my $20 balance by 2% (to $20.40).  Any money I put in after that increase in balance would not be subject to that increase[4].  This allows me to still make the same number of trips before and after a fare increase, but also helps fare income has the same real value from year to year[5].  In addition, balances should also be increased  by the rate of return the State Government gets on the money invested[6].  If the Myki Fund is returning 5% on the amount invested, balances could be increased by this amount annually (as with footnote 4, probably 5% of the average balance in a year).

Wrapping it up

I’m aiming to write short pieces on things that are happening to consider how basic economic concepts can be applied to real life in a way that helps to understand those concepts.  I’m not proposing public policy here – I’d be amazed if any government would do anything other than offset the profits from the two problems identified above against the losses from single trip tickets, not to mention the $1.35 billion (at least) that Myki has cost.  But hopefully this has you considering money and value, how they can change over time, and the effects of leaving money stored in a card that doesn’t increase with value over time, rather than leaving money in your bank account (or better, paying off any debts you may have).

FOOTNOTES
1. It’s likely that this will have a significant impact on ticket income, but there was never going to be any other way to implement it.  Given a single two hour zone 1 ticket is $3.70, imagine the outcry if each Myki trip cost you $0.76 more than the equivalent bulk Metcard rate?↑
2. I can’t find who owns the money stored in travellers’ Myki accounts.  I’m assuming the State Government does, but the argument holds irrespective of who keeps your money.  If it’s shared between the private consortia who are managing the public transport system, it represents a bonus for them.↑
3. Clearly, $50,000 is not a lot of money.  My point is not to suggest that there’s some grand plan to rake in loads of cash at the expense of travellers.  My point is to help you think about money and value over time.↑
4. And we introduce a new problem – if I then put in $100 on December 31, I get an increase in value of $2.  A better version would be to increase the value by the mean value stored on the card throughout the year, but my simpler example above serves as a theoretical explanation.  Software makes such tasks trivial.↑
5. In a period of sustained deflation, it would be impractical to reduce balances if fares were reduced.  But no government would actually reduce fares, so there’s no substantial problem here.↑
6. Again, a theoretical example – it would cost much more than $50,000 to return $50,000 to 500,000 Myki users.  I am not actually suggesting that this should be implemented (whereas the balance increase at the same time as a fare increase one probably should be).↑