In a blog post at the Washington Post’s “The Switch” site yesterday, the usually reliable Timothy B. Lee set out to analyze pricing in the market for Internet access services. I have a lot of respect for Tim, but his blog contains some pretty fundamental economic errors that need to be set straight.
Most important, the blog buys into the long-discredited notion that price discrimination implies monopoly power. Reviewing Comcast’s tiered pricing plans (faster access costs more), it concludes – correctly – that “Comcast is engaged in what economists call price discrimination.” But then it goes on to opine that “Comcast’s strategy only works because Comcast faces limited competition in many markets.” That’s wrong.
Economists have understood since at least the early 1980s that price discrimination can and does occur in competitive markets where there are large sunk costs. (Then, the issue was airline pricing.) Not only that, but it is widely understood that price discrimination in such markets is not only possible, but necessary, and not only innocuous, but welfare maximizing.
I would be remiss if I failed to point out that much of the seminal work on this topic was done right here at AEI, by Bill Baumol and others. As Baumol concluded in a 2005 AEI Distinguished Lecture, in high tech markets “discriminatory prices are not haphazard in their welfare properties but will generally constitute a Ramsey optimum.” But I should also note that the concept is accepted by virtually all competition economists, and that there is widespread agreement that it occurs in high-tech markets. As Jonathan Baker wrote (a decade ago):
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