Arnold Kling explains partly why stores offer Black Friday (day after Thanksgiving) sales: price discrimination (see below the  fold).  Price discrimination is the practice of charging two (or more) different groups of buyers a different price for the same thing.  The idea is to charge a high price to people willing to pay a higher price, while only charging the lower price to people who wouldn’t buy it at all at the higher price.  Net effect: more revenue to the seller – a higher average revenue per unit and higher volume than if all customers were charged the exact same price.

Of course, the ultimate theoretical extreme of price discrimination is the monopolist who figures out the maximum each individual might be willing pay to acquire the product and then charges them just that.  In the ultimate case, all surplus and benefit from trade goes to the monopolist, and none to the buyer.

In my high school economics class, my students asked me to explain why there are sales on “Black Friday.” The class period was over, so I only had time to blurt out “price discrimination” without getting into an explanation of what it is and why it explains sales.

I think that price discrimination really deserves a lot more attention than it gets in the economics curriculum. A lot of “economic naturalist” sorts of questions are correctly answered by appealing to the concept of price discrimination. I think it explains airline pricing, credit card pricing, cable TV pricing, cell phone pricing, movie popcorn pricing, etc.

Suppose that a new video game console comes out. BZ likes video games, but he is only willing to pay about $200 for the console. JS lives for video games, and he would pay $400 for the console. The manufacturer would like to charge $400 to JS and $200 to BZ. However, to do so blatantly would be illegal. It might also be impractical–what is to stop BZ from buying two consoles for $200 and selling one of them to JS for much less than $400?

The console maker looks for ways to price discriminate. There might be a “standard” version of the console that sells for $200 and a “deluxe” version that sells for $400. If the features in the deluxe version appeal to JS but not to BZ, this will work. Or the maker might release the console initially at a price of $400, wait three months, and cut the price to $200. If BZ is willing to wait but JS is not, then this will work.

Back to the original question, temporary sales are often a tool for price discrimination. If you need something now, you have to buy it whether or not it is “on sale.” But if the purchase is discretionary, you may only buy it “on sale.” The store keeps its prices high ordinarily, in order to pick up profits from the price-insensitive shoppers. The store puts items “on sale” on rare occasions, hoping to pick up profits from price-sensitive shoppers. Unfortunately, they lose profits from price-insensitive shoppers who happen to come in the day of the sale.

The beauty of holding sales on “Black Friday” is that stores know that many price-insensitive shoppers will stay away in order to “avoid the crowds.” So you can get revenue from price-sensitive shoppers without sacrificing profits from price-insensitive shoppers.

via Price Discrimination Explains Everything, Arnold Kling | EconLog | Library of Economics and Liberty.