The Aresan Clan is published four times a week (Tue, Wed, Fri, Sun). You can see what's been written so far collected here. All posts will be posted under the Aresan Clan label. For summaries of the events so far, visit here. See my previous serial Vampire Wares collected here.

Sunday, August 21, 2011

Strategic Pricing

I just finished reading Traffic by Tom Vanderbilt and he has an interesting discussion of free parking. On the one hand there's the idea that more parking encourages more driving (since more people will drive to an area where they have a better chance to find parking), but also, on the flip side, that a shortage of parking is an indicator of underpricing. Especially as I've been recently taking a few trips to Chicago by car, I've noticed that there are some parts of the city that are flush with parking, and others where it's incredibly scarce, and that there's a mix of free parking and pay parking, but all the street parking that costs, costs the same (so far as I saw). Another author (Donald Shoup) had suggested, as a rule of thumb, that parking should be priced such that you're always 85% full. Areas where there are chronic shortages of parking, should have their prices raised, and places with there is excess supply should have prices dropped or parking spaces eliminated. This also suggests that you adjust pricing for time of day, such that it's more expensive during high traffic times (for most places, during business hours on weekdays) and cheaper during low traffic times.

Now, while I was reading about this, I was waiting for him to apply the same idea to highway traffic. Sure enough, he did. This being a book about traffic, it would seem inevitable that he would talk about solutions to congestion and excessive traffic. Just building more roads is not the answer, since it always runs up against the "if you build it, they will come" phenomenon, whereby more people drive and those people drive more if they have less traffic to contend with (meaning new roads will almost always be filled to capacity and beyond). You've got to think of it as if providing free roads to drive on is like subsidizing driving, and providing more roads is subsidizing it more, and if you want more of something, the best way to do it is to subsidize it. Additionally, more roads just exacerbates the problem that most roads are underutilized during times of the day that are not rush hour (especially late at night and early in the morning).

The solution is "congestion pricing." You charge people for using a road during high traffic times, and perhaps charge them even more during really high traffic times. This forces people to make price/value calculations: "Is it worth it to drive now, or can I wait a few hours until it's cheaper?" Some people will decide it's worth it to go during high traffic times, some that it's worth it to go earlier or later, some that it's worth it to use another form of transportation. The ultimate result is that, if the pricing is done well, traffic will be lower and will be more spread out throughout the day.

This type of strategic pricing is used in other industries: airlines charge more for more popular times of day (early morning and late at night are usually the cheapest), more popular days of the week (Tue-Thur is usually the cheapest), more popular times of year (Thanksgiving and Christmas/New Years are super expensive), and charge usually less for early purchasing. But I think it's surprising that many other industries don't do it more. For example, though movie theaters have modest matinee discounts, they don't charge even more for high traffic Friday and Saturday evenings and don't lower prices more to fill up theaters during less popular times; not to mention lowering prices for less popular movies, and raising prices for more popular movies. I'm surprised how concert tickets sell out quickly, when the venues could've sold them for much higher prices, leaving tickets available even for people who buy them last minute and virtually eliminating any secondary market (ticket scalping). It's not a solution for every industry, but it should be used more.

Pricing can be a good way to adjust human behavior, and in fact really helps us make decisions, giving us a tangible prices with tangible numbers that can really help us evaluate whether something's worth it. Free parking genuinely costs money (since that space could be otherwise utilized) just as highways genuinely cost money to build. Additionally, more in demand times and places are genuinely more valuable to people, and thus would demand higher prices. Giving a tangible price to something and forcing them to pay it forces upon them decisions that help further a more efficient allocation of scarce goods.

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