I*$RA»00*&U#BR P&IGB DIGGAIMIBATIGR A8 A MSWB8 OP IBCRBAGINO *ILK GO&BUMPTIOB 8&*la B# J@B#a A# ABsmAGT ao&altt#d to t&e Gohaol of Opmdwat* Gtudl** of %lo&l&*a 8t#t# Gollogo of A&ploultufo aad Applied Golaae# la partial falflllmeat of tb# #0gulrea#8%* for the degree of BOGTOR OP milLOGOPdl Dep&ptaeat of Agploultaral Seonomio* 1%3 Mwim 3» imm I T&# porpo## of tbi* @$ydy &a# boon to lavoatleat# th# foaolbllity of wolo# aome ompoot# of prlo# dloorlmlnation a# a moan# of iaop*&*ia# fi&ld milk eoa&qmptio& in ooB# morkotB# Tho Invootlgotion h&e givoa oonoidoration to tb* po#8ibility of noina thm prioo dlfferontlol botaoaa Glaoo 1 Of flaid milk and Bonnfaotufio# milk in pfiola# aa& ppamotioABl p#og#**@ &* &a iaoomtlvo for ooaauaof* to inof###* Bilk ooG*g*pti&a, Gfad* a milk in a%@*a# of fluid milk f#qwlf@*aa&* 1# y*m&lly diverted to lower w*« prodwot# $*eh a* butter, evaporated milk* ete*, during period* of inoreaeed ae&aon&l produ@tlo&. Tbi* study ooBtend# t&at In #om* market*, it i# fooGlblo for dealer* to bottle *00* of this milk and pay tb# produeer* manu» faotnriB# milk prioo* for it* T&l* aotivity oould lead to a prio# roduotioa for bottled &%oo#* fluid milk that eowld be ##**#& on to tbe ooaeumer in an attempt to enoowrage inore&aed milk ooneumption* In addition to the prioe differential between fluid and m&aufaoturing milk prioea, other aeonomi#* baaed on marginal ooat *r* *1*0 poaeible in the marketing of milk that eould be i&*#& to reduGO further the prie* of bottled aurpiu* milk. It i* proposed that thi* bottled murplua fluid milk b* Bold under a two prie# eyatem of iAtramoonaumer price diaorimination on * *e*#on&l b*#i* to oorroapond to the M w i n B, Somê a lae*»&#*d eaaaomal prod98%ls& of Opad* A m&I&, Faalll&e %&#* h&v* most of tbolr milk aollvorod or* boot suited for tb@#* pfOgfOM** It 1* suggested tb&t moat&ly bee* ##d ewrplu* oliotmoot# be alloe&ted to femlll*# who could p&ftlelpote iR program* oa a voluntary be#!#* The be** allotmeat mould eorreepomd to probahle puroha#*# of fluid milk at the régula# retail paieo for the period. The aupplu# ellotmeat *ould ooaaiat of &a allowmaoe of milk that the family oould pufoheeo at & dieoouatod price after puroheeiBg their beae allotmoBt, if they de&ired to do 80# Program# of io&ramoeaeumer pria# &i»arlmia8tio& mould thus attempt to *el*ot from the market theee femiliea *ho are iBOllned to i#orea*e pureh*»*# a* a reault of pria# reduatioQ# #ad offer to them #urplu# fluid milk at a reduced prie#. The feaal point of iotr#*ooaeumar prie* dieerimlnatloa iBVdlvlBg fluid milk ia the reapoaae of the ooaaumer to &uoh program#. A# aa aid in obtaining & oonaeptual fraae* work whloh would explela some of the proha&le ooneumer reeotiona, reaour## aa* made to partial #qullIb%ïB* anelyal* and the tool# of &loro#*tatlc eoonomio*. Gomp&riaon# were made between pricing poliole* involving retail price BaintenanoG, uniform price reduction* end prig# reduction* involving intrG-oonBuwer prie# sdwla a, Jo#** 3 It *&# found that conaumar** welfare ahowld be Improved by selling all# throu&b dlaorlmlaatory prograao during ln8re&&ed aeaaonal praauotlo& &* oompared to pollol*» of retail prise Balnten&noe or a aaall flat price re&uetla&, Pr&otlo&l problem* Involved In In&ugaratl&B and operating dlaorlmlBatory program* were o&atered around two general &re#*t (1) Devlalag program* that would alBialae resale or substitution of eurplu# prloe dleoouated milk for allk *old at the regular prioe, and (&) formu­ lating program* that would be mutually aoeept&ble to producer*, dealer#, routeaen and other# oonoamed with the marketing of ailk* OonaldaratlOB wa# given to the po##ibility of wain# fluid eream &nd/or Ohoeolate ailk in diaoriminatary program*, &# well a* atemp* and ooupon*, ea a mean# of overeomiag @ome of the problem* Involved with program# oentered around bottled fluid Bilk. IRTRA»GORGÜWBR PRICE DI&GRIMIRAliaW AS A BEA&S Of INCaE&GIRO WILK COWaOKPTlOB M w i n B* JoB#* A TREGIB Submitted to the School of Graduate studies of Michigan State College of Agriculture and Applied Science partial fulfillment of the requirement# for the degree of DOCTOR OF PhlLOSOPHf Department of Agricultural Economie* ProQuest Number: 10008343 All rights reserved INFORMATION TO ALL USERS The quality of this reproduction Is dependent upon the quality of the copy submitted. In the unlikely event that the author did not send a complete manuscript and there are missing pages, these will be noted. Also, If material had to be removed, a note will Indicate the deletion. uest ProQuest 10008343 Published by ProQuest LLC (2016). Copyright of the Dissertation is held by the Author. All rights reserved. This work Is protected against unauthorized copying under Title 17, United States Code Microform Edition © ProQuest LLC. ProQuest LLC. 789 East Elsenhower Parkway P.O. Box 1346 Ann Arbor, Ml 48106 - 1346 the author hm heeu greatly a**lated with thi© ©tudy by am umhelievabl# mmb#r of poopl#— each in hi# mn wgy a#kim* *08# diatlBotiv* ooatributioa th&t omly be, perbapa, could make. To mention any i* u m v o M m b l y to omit m n y *bo #bould b# named, however, the inability to @%pre** gratitude completely and perfectly i* not mmm enough to refrain from recognizing anyone at ali--and ao tb# author venture*. First of all, appreciation of a particular kind and degree auat go to Dr* Gerald &. Quackeabuab, for the helpful euggeation* and patient direction wbiob greatly facilitated the taak of preparing and preeeating this manuacript. The author i* indebted to Dr* Thoma* Cowden, who helped to make a graduate program poeeible and whoa* underBt&nding encouragement and confidence be* alwey* been appreciated. Gratitude 1* expreaaed to Dr. Victor C. Smith* who helped to formulate part of the tbeoretio&l aapect# of tbi* Btudy and who gave a degree of aaeura&oe in ueing some of the analytical tool* of economic*. Tmnk# 1* û m Dr# OZenn Johnson, Dr# James G# Shaffer aad Wr, H&roia M. Blley for taking time from the preaeor# of their day* to read thl* maBuaoript and for offering aaeietaaoe a@oor&la& to their varied training and talent*. Appreciation i* e&preaaed to many persona aaaooiated with the dairy industry in variou* capacitie* #ho offered many criticism* a* *#li a* much encouragement in formulating and completing thi* etudy* Thank* i* aleo expressed to some graduate student* and member* of the Agricultural Economie* Department staff who** help ha* been 1*** specific but act less appreciated* last, but not least# the author is grateful for the encouragement and inspiration of hi* wife# Mildred, and son* Rick* who always amde the tasks of graduate work seem worthwhile* Although the assistance of many person* is hereby acknowledged, the author assumes full responsibility for any errors or iaconsisteacie* that might be found in thi* manuscript* TABL& OF CONTENTS Page Gh&ptér I IBTRODUCTI:# , ......................... General setting for the Problem II , 1 1 Objective of the Study # , , . . * 5 Outline of th* Discriminatory flan 6 Method of Procedure 9 , » . . * . , T&5 MATURE ABD 8G0PE OF Thl PhOBlEM 13 Reaeat Development* Affecting the Fluid Bilk Industry * . , # . . , , . 13 Quality Requirement* can Discourage Consumption . . . , , , . . # , 14 Producer Price Differential between Fluid • * and Manufacturing Milk . * , . . 28 I&creeaing the Differential of & Two Price Gyatem * ......... * . . , 25 AdvaatG&e of Extending the Period of DiaorimlGBtlon , . , « . , . , . 30 Market %ide Price Discrimination . @8 Price DiaeriBin&tion aa & Competitive Policy for Individual Dealer* , , , 33 Flexibility of Seaeonal Price Discrimination . , . * . . ....... 34 Educational and Promotional Program* Ghould Complement Price Discrimination 56 Characteristic* of An Ideal Market for Price Discrimination . . . . . . , . * TABLE GP G0KTEBT8 (Com&lnwad) Chapter III Page TKBOBBTIGAL ABPBO&B OF IBTRA#G0m8UmBR 8&ABÜHAL QUANTITY PRICE DIS&&IMINATIQN . 41 The Role of Consumer** Dewe&a . . , » . # 41 Wl@k** Theory of Gubjeotlve Value & 44 V # # » 47 Deriving a Demand Curve from Indlfferene# Curve* 54 Limitations of a Demand Curve Baaed oa Uatform Prlolag , . * , . . ........ 57 The ladlffereRo# Curve Teohnlque Prie# DlsorimlBotlon Involve# Buaee#*!?* A c tio n IV * * . , * , . # . . . , , . . , 60 Deriving & Dleorl&lnatlon Demand Curve from Indlffereae# Curvee # . . . , * , . , , 63 Meaning of & Dlaorlmlaatloa Demand Curve 68 Ublform and Perfeot Dleerimlaatory Prioing a* Limiting Caaea * ................. 70 A Two Price Cyatem of Pricing » % 78 Various Pricing Patterns Affeet Mature of the Demand Curve ........ 77 DtfferBWtl&I in & Two Price Gyatam 79 * * * . . , THE EFFECT OF PRICE E&A&TICITY OP DOmaND UPON POUCIBB I^VOIVIBO QU/BTITI P&IC& Dl&CaimiBATlON , . . . , . . . . . . . . 86 The General Caee# of Price Elaatlclty of 06 DeMand The Elastic Case with Flat Pricing * . , 88 TABLE OF G0BT3NT& (O om tlBwed) Chapter Page Th# &l&8tl8 Cea* with Dlsgrlml&at&ry P f iQ iO g , , , * . * * , * # * . . 90 , Height of ladlfferoBG# Curve * Meeaure of Income Effects end Consumer Welfare , , 93 Substitution Effect* In the Elastic Case 96 Bumm&ry statements for the Elastic C&ee # 97 The Inelastic Case with Flat Pricing , , 95 The Inelastic Case with DlGcrlnln&tory Pricing . . . . # . . , , . # # . . , . 100 gUMwary #t&t#BABts for the Inelastic Case 101 Limited Gubstltutlon Effects in the Inelastic O&se . * . » » . , , . , , . 105 Boms Favorable Results of the Analysis 106 , ANALYGle RECOMRlnmRED ÜKD&R THE A8&CKPII0B THAT T&B K&HGI&AL UTILITY OF HOB&Y 18 GONCTART, * . . . , , , . * . , ..................... 105 Validity of Bbrshall** Assumption in the Purchase of Fluid Milk , » , , . » , , 108 Marginal Rate of Substitution Independent Qu&Btity of Money . , , . * , , » . 109 Deriving a Demand Curve ^hen Marginal Utility of Money is Gonetant* . , . 118 Unique Nature of Demand Curve %h#a Marginal Utility of Money i* Constant 115 Income Effect* do not Affect Quantities Purchased 114 Preferred Patterns of Pricing . 116 TABLE OF 00NTE8T2 (Conti#**#) Chapter VI Peg# Bummaay Statementa When the M&f&lB&l Utility ef #oB*y la Ooastaot. . , , , , , 117 Digression* # * # # * * * * # . * * * « * * 119 Meglectlng Inaom* Effect* , * * . . * * . * 119 A Limitation Plaoed on Analysis by DlBlniehlng Marginal Utility of Money . , l&l Coneumer** Surplus il&B , * . * % . . . , . . . PRIG& DI8GR1M3%ATI0% AÜD laZ THEORY OF THE Flhfei * # * %' « * * * * # * * #f * Aggregated Market Demand *. * *,.#1&6 gqullibrium of the Firm under Plat Prlolag# 189 Equilibrium of the firm under DlBorl&laatlon * . * * , . . * » * * . . 1&8 Nature of Marginal Cost Curve under Di* orlmination * * . * * * . * # . . • * 13# Effect* of B&QOomle* la Distribution on Marginal Coat Curve * * * * * * . , * . * 159 Discrimination Requires Cooperative Effort# 14# 7*0 Point* Emphaslaed » . ,. Results Suggested by Theory VII *. #f**126 LIMITATIuNa AND W&AKKE&GBG .. * ..»* 14& of the Firm * , * . . ........ Some Assumption* of Gtctlc Economics * . * 151 168 168 Partial Equilibrium A n a l y s i s ............ 163 Indifference Curve Analysis does not Handle the Preble# of Complementarity * * 164 TABLE GP GOBTBNfB (Cantina*#) ChApter VIII P&g# The A#*amptlan of national Behavior # » . * 157 Tlae Perla# Mjaetmmt® 160 Pria# Elaatiaity of Demand Through Time . * 168 Adjustment# Beaauee of Change in Teat# * , 165 Area# la Whioh Careful Weighing 1# Absent . 169 The Problem of Indivisibility 171 Conclualon# 173 80BE A6PECT& OF OPE&alIÜN&L PL&N8 OF PRICE DiBcaiMiaariGR......... . , . . . . . , 176 The Policy of On* Price * ♦ . * . * . # . » 175 Example# of Intre-Conaumer DlBerimination , 179 Pria* Diaarimlnatioa for Delivered Milk . # 186 The Uniform Delivered Puroh&ee Pattern , 195 . Pureha#* Pattern# Involving Irregular gua&titie# per Delivery * . *. . * . . , 199 The Sffeat of Price &i#ari&in&tion on Average Pria* * , # . . , . «. . , , , # 807 Pria* Discrimination and Relative Inareeee# in Consumption , . . , , , , Price Di#Qrimln&tlon and the General Movement in Milk Price#......... . , # . 811 814 Price Discrimination Involving store Purchase# of Milk £16 Use of Coupon# In Program# of Price Discrimination £19 TABLE OF G0BTBRT6 (Continued) Chapter IX Page The 9be of Alternative Dairy Prodoet* in Dlmorlmlnatory Programs 884 Choeolat* %llk * , , . , . , . . . . , . . . &8& Fluid Cream 889 PRACTICAL PaOBLEBG IBVOLVËD 18 IB1TIATI80 AMD 0PB&ATI80 Dl&aaiMl&&TOWY PR0GRAM8 FOR FLUID %ILK . . . , * . ............... Cooperative Effort Required # # . # # # . . 23B Comparleoo betweea Rellaf#Milk Program* aod Intra-Conaumer Prloe DiserlmiaatlGa * 834 Role of Producer# in Prloe DlaerimlBatlon # B58 . # . . 846 Price Discrimination and the Dealer The Role of the Dellverymaa * ............. Initiating Program# of Dieorimlnation % j&BB agWB&RY AMD COBCLGSIO&B 861 , . . 867 , . , . . . . . . . . 869 L18T OP TABLB6 fa b le i II III 17 Page Prie* of milk for Fluid 9## L*## Prie* Paid by Codd#m**ri*o » . * . * . • * » # * . 83 Goat of Distributing Milk through Store# aa Measured by Dealer# * ù m m Sandliug Margin* 87 Relationship of Kind and Quantity of milk Purehaaad to Soure* of Purchase by 101 Consumer Panel Pamlliaa 191 Number of Families Purchasing Fluid milk from Various Sources of Purchase by 101 Consumer Panel Families , , , » . # . , . , 198 LI8T OF FIOOREB Page I M m â 8a 3 and 5a Substitution A M iWome ËTfect# from Indlffereaa* Curve Analysis 50 D&riv&tloa of a Conaumor*# Demand Curve u M t r Uniform Pricing 55 Derivation of a Coosumar*# Discrimination D#m#M Curve under Perfect Price D is c r im in a tio n 4 6 and 5a 6 66 Comparison between a Consumer*© Demand Curve for Uniform and Perfect Price Discrimination 71 Derivation of a Coneumer'a Demand Curve under a Two Price System of Discrimination 73 The Problem of Indivisibility end Effective Demand 80 7 Demand for the Marginal Quart 80 8 Indifference Curve An&lyals when the Price Elasticity of Demand is Elastic 9 10 and 10& # Indifference Curve Analysis when the Price Elasticity of Demand is Inelastic Derivation of a Consumer*# Demand Curve when the MhrglBsl Utility of Money is Constant # . . , 4 89 99 . 1X0 11 Effect of a Two Price Gystem of Price Discrimination on Quantity Taken . # . . 130 IB Effect of Marginal Cost on the Price Differential in e Two Price System of Discriminât ion . 138 OmPTER I mcRODUcTim for, the Prablem The phyelcal charaoterlstlcs of milk and the season* aiity of production have brought about many difficult and eomplloated problem# Im marketing milk in its various forme. Although milk la a rather homogeneous product It finds its way to the hands of the consumer through a very complex marketing and pricing structure. true for bottled fluid milk. This is especially Every city, or geographical market, has Its own peculiarities and problems. Individual markets have developed pricing practices that have been tempered by the various Interests concerned with particular phases of the market. Through the years pricing policies have been shaped and adjusted to meet these unusual con* ditions, so that throughout the United States more or less distinct end heterogeneous mw'kets for fluid milk have arisen. Although each fluid milk market is somewhat of an entity within Itself, indirectly ail fluid milk markets are interrelated, at least through national markets for processed product® such as butter. A limit or range is & placed upon the internal prising pollolee that can be pursued in a given market by the économie forces generally operating In the industry. However, within these limits wide differences in the various production costs and marketing spreads can and do exist, both within and among markets, that are conducive to a variety of marketing and sales techniques. Fast experience in most fluid milk markets, among other things, has shown two broad generalizations to be true; (1) that the production of milk experiences seasonal variation, considerably more milk being produced In the late spring and summer months than in the fall and winter months, and ÇE) that the consumption of fluid milk is fairly uniform from month to month. Pricing policies end practices for fluid milk, both at the consumer and producer level, have been formulated in most markets around these two points so as to attempt to maximize the returns to the dairy industry. The price elasticity of demand for fluid milk in most markets Is generally considered to be inelastic at prices end quantities usually encountered In the market.^ such studies as E. W. Gauzsnltz and 0. H. Reed, "Some Problems Involved in Establishing Milk Prices," United states Department of A&rloulture In eueb eireum©tances the usual procedure for the Industry is to attempt to maintain a rather rigid or stable price for fluid milk at the consumer level* Instead of lowering the price to encourage ooneumptlon during seasonal Increases la production* fluid milk that Is in exce&s of bottled milk requirements is diverted to so*oall@d lower use products such a# cheese and butter. In this way fluid milk supplies are equated with demand at the fixed price. In many markets producer pay plans (e,g* classified use plans, etc*) are specifically designed to reflect directly the diversion of excess Grade A milk into lower use products. Dealers are obliged to pay for milk going into bottles at fluid milk or Glass 1 prices* while Gradé A milk In excess of fluid milk requirements is sold at manufacturing milk prices. The differential between Grade A and manufacturing milk prices supposedly represents the difference in the producers * costs of production for the two grades of milk, Although diverting Grade A milk in excess of fluid milk requirements to lower ricultuyal ______________ D%~8 , Gharles J, Blanford, "The Demand for Milk and Cream as revealed by Consumer Purchases at Retail Stores in lew York City*" Cornell University Mrloultural Experiment Station Bulletin 765* 1941,, Resort of the Mew York Milkshed Prlae Committee, as transmitted to the Market Administrator* New York Metropolitan Milk Marketing Area, 206 East 42nd Street, Mew York, Mew York* p. 46, 4 us® products mocomplishea the purpose of retail price mel#tea&&Q@ for fluid milk, the milk Is not used for the purpose for which it was produced, This diverted milk falls to reach the hands of the consumer la the form of bottled fluid milk, la a sense, the diversion of this,higher cost milk to lower use products Is a social lose* The importance of attempting to encourage consumers to drink and use more fluid milk is readily seen when one considers the nature and trend of the market for some of these products. The procedure of retail price maintenance for fluid milk during the seasonal Increase in production means that price is not used as a mechanism to Increase fluid milk consumption* It is not the purpose of this study to challenge this general pricing policy. On the contrary the aspects of price discrimination that will be investi* gated in this study are predicated upon the proposition that a policy of "holding the price* for fluid milk will continue to be a part of the market structure. Aspects of price discrimination will be considered as a supplemental rather than an alternative pricing technique to the policy of holding the price for fluid milk. 5 ■Within many fluid milk markets dynamic factors are constantly bringing about changes that lend themselves to new praotiee® and Innovations# Under the conditions existing at present in the fluid milk industry, pricing end marketing practices found in many* if not most, fluid milk markets ere such that the consumption of fluid milk is not encouraged as much as it might be, especially during periods of seasonal increases in production. Given the usual framework and marketing structure within which fluid milk Is sold in many markets, possibilities seem to exist for using marketing and pricing techniques that might encourage the sale of more fluid milk which would involve some gain or incentive to both consumers and the fluid milk industry* The objective of this study is to investigate the possibilities of increasing fluid milk consumption in some markets* More specifically, this study will consider some aspects of price discrimination as a means of in­ creasing fluid milk consumption. The objective of this study can be formulated into the following hypothesis * That the per capita consumption of fluid milk can be increased in some markets through pricing and promotional programs involving price discrimination at the consumer 6 level which would be acceptable to consumer®, dealers and producer#. It is the contention of thl# study that the differ­ ential between Grade A and manufacturing milk price# can be used In pricing and promotional programs to Increase the consumption of fluid milk in some markets, The differential for Grade A and manufacturing milk price# 1# primarily the result of seasonal fluctuation# in production. Therefore the proposed plan# of discrimination will also be seasonal to correspond with the fluctuations in production. Outline of the Discriminatory Plan The basic plan to be presented for increasing fluid milk consumption involves Intra- and inter-consumer price discrimination# Intrm-consumer quantity price discrimi­ nation la hereby defined as the situation where an individual consumer Is oharged different prices for various quantities of the same product* A common example of Intra-consumer discrimination Is blcck-rate schedule# for Individual consumers covering the sole of electricity by power and utility companies. Inter-consumer price discrimination is defined for this study as the situation where different Individual# or groups of individuals pay a different price for the same quantity of fluid milk. 7 In other word®# on® prie# or pattern of prices does' not prevail for all the comsumere In the market. Thl# study propose* that a modified base and surplus plan be established for individual consumera who could participate In price discriminatory program* for fluid milk on a voluntary baa la. The baa# for the consumer would consist of an allotment of milk that corresponded to the usual quantities purchased. This milk would be priced at the regular price prevailing In the market. After the consumer purchased this quentity of milk at the regular price* he would then be given the opportunity of purchasing additional "surplus’* milk at a reduced price. In other words* a family could be allotted a base of 60 quarts of milk per month for which it would pay the regular price prevailing In the market. Fluid milk purchased above the base allotment would be sold at a considerable discount as a means of encouraging additional consumption. The consumer** base and surplus plan would be Instituted on a seasonal basis. DiscrIminatory programs would be primarily centered around delivered milk. During some predetermined period consumers would establish their base and in the spring and summer months, when milk production Is Increased and when Grade A milk is in excess of fluid milk requirements* some of the excess 8 milk would be sold under dlsorlmlaatory programs. The price differential between fluid and manufacturing milk would be used as the basis for price discounted surplus milk, Seles at the discounted price would be realised without adversely affecting fluid milk sales at the regular price. In addition to the price differential between fluid and manufacturing milk, it is the contention of this study that marketing margins could be reduced for the milk sold to consumers as price discounted surplus milk. In other words* if dealers* route men* etc,, were attempting only to cover their marginal costs plus a small profit for handling this surplus milk, further savings could be affected which could be passed on to the consumer in the form of a greater discount on surplus milk, thus a still greater incentive would be given to encourage more consumers to purchase additional quantities of price discounted surplus milk. Price discrimination would thus attempt to select those persons in the market who respond to price decreases by purchasing additional quantities of milk. Those who are not responsive to price decreases would pay the regular price for milk. This segregation of consumers according to response to price reductions involves inter-consumer discrimination. Charging individual 9 o m p r i m for base milk and a lower prie® for aurplua milk constitute# Intra-emsumer discrimination. The#* aspects of price discrimination will be investigated as a means of increasing fluid milk consumption in n o m markets. Method of Procedure The hypothesis of this study will be tested by resorting primarily to economic theory. It will be the purpose of this study to investigate and postulate the theoretical framework that would justify the inauguration of die criminatory programs for fluid milk# Theoretical aspects of consumer demand under the assumptions of static economics will be critically analysed in an attempt to establish some probable consumer responses to programs of price discrimination* Borne primary and secondary empirical data will be presented to substantiate some of the theoretical findings, However# many of the theoretical concepts and propositions that form an Important part of this study cannot be subjected to empirical proof until actual programs of discrimination, are put into practice# Laboring under the assumption that what is theoreti­ cally possible and desirable is physically possible and 10 desltablê, a theomtloal framewrk will be preeeated to teat the feasibility of price aiaorimlnatloa aa a meama of imoreaalhg the oonauaptlon of fluid milk. The ana* lytlool model# that will form the ooupomnt parts of the gemaral framework will ofteh be stripped of their refine­ ments, #omlatent with the meed of adjusting them to the particular problème that they are deeigoed to clarify# With reference to the fluid milk industry this study is general, from which It la hoped that applieatloma can be made to specifio situation#^ From these applications evidence would be fortheoming to prove or disprove empirically the validity of the general theoretical contentions# In general# the analytical techniques used in this study will consist of partial equilibrium analysis and the tools of static micro-economics# In most instances segments of the dairy Industry will be ignored, or assumed constant, except those individuals, organisations or functions directly associated with the consumption and sale of fluid milk* The theoretical portion of this Study will consist first of an analysis of Individual consumer's demand under the assumptions of diminishing marginal rates of substitution# %pctheticol demand curves for individual consumers will be derived from u Indifferenee curves where the eeme price is charged for all unite sold# m This pattern of pricing will be known uniform or flat pricing. Patterns covering various degrees of quantity price discrimination for Individual consumers will be contrasted with and differentiated from policies involving uniform pricing* Comparisons will be made between uniform and dlscrlmi* natory pricing for individual consumers when the price elasticity of demand is relatively elastic and inelastic. An aggregated demand curve for a market will be postulated and the theory of the firm will be used as a tool for explaining some of the theoretical problems and relation­ ships Involved In initiating and operating programs of price dis crimination. The theory of the firm will also ■ be used as a means of investigating the l;%fluenee of changes In marginal reveme and marginal cost on programs of price discrimination. 64 EH M EH 1 P D O* 0 Quantity -of Commodity B FIGURE 1. Substitution and Income Effects from Indifference Curve Analysis 51 prl## Thle effect le eimiler te am imerease ia income # M is amalysM Im that light» On the other hand, the smhstitmtlom effect comes about because relative prices have changed shich leads to the tendency to substitute the commodity whose price has fallen for the commodity (or commodities ) whose price has remained unchanged. These relationships are also shown graphically in Figure 1Fh represent## in terms of â» the supposed increase in income that would make one as well off as the fall in the price of commodity B# G# is parallel to FQ., indicating the same price ratio between the two commodities as existed before the fall in price. Point J is the equilibrium position for the quasi increase in income. BJ is the income effect Indicating that had income been increased from OF to 00* J would have been an equilibrium position at the former price ratios. indifference curve. J and S are on the same JH is considered the substitution effect since it represents the shift from the purchase of à to the purchase of B* merely because the price of i has fallen in relation to the price of A. It should be noted that in Hicks» analysis of these two steps, income effects (positive) always involve the movement to indifference curve® situated to the right or above, representing a higher level of satisfaction (II to KK eta.). m Bubstitution effects* on the other hand, are limited to movements along (either up or down as from J to ii on KE) the same indifference curve. These two propositions concerning income effects and substitution effects are important distinctions to keep in mind when considering problems pertaining to quantity price discrimination. It is from the indifference curve technique# which reveals income and substitution effects* that Hicks justifies end verifies the properties of a demand curve for an individual consumer* Beginning with the elementary case involving two commodities as shown on an indifference map* Hicks presents an insight into the requirements and conditions that must be valid to warrant particular demand situations. From the results obtained with the indifference technique* generalisations are expanded to explain more complex relationships. In summing up his inquiry into the law of consumer*® demand* Hicks makes the following state-» mmt9 "The demand curve for a commodity must slope down­ wards* more being consumed when the price falls# In all cases when the commodity is not an inferior gcod*"^ Exceptions are justified in the case of Inferior goods where a large negative income effect might outweigh Bibid.■ p. 36. m a- substitution effect* which Hicks eoasiders m mmimportmt# rare a M His techniques lead te some rather startling results in the Q i s m m t m m where an individual acts as both buyer and seller. Biace in this problem consumers will be considered as buyers of milk only, further cement on these points will not be made. However, an analysis of dairy farmers as buyers and sellers of milk by this method might prove very interesting as well as useful, The above brief summary and oonelusions pertaining to demand as found in the writings of Hicks and others are presented in order to establish a basis upon which some of the properties of a consumer»® demand curve for fluid milk can fee fomulated, Gome of these basic concepts will be used as a foundation in laying the framework for considering some of the problems involved in pricing fluid milk. Variations in income and substitution effects for various price patterns and policies will become an important component of the many factors that have to be considered in trying to understand and analyse the consumer's reaction and response to price changes Involving various pricing techniques* m MEÈsâm KMmM... Gurvm The indifference curve analysis will he used as a hails in oonetruoting a hypothetical dmand curve for fluid milk* Suppose milk is represented on the ahsoissa. and income or money on the ordinate (Figure 8), or lno It la very possible that the conswaer might be interested in additional quantities of milk at lower prices after the transaction at BO cents per quart has been completed* However, there is no way to discover these quantities at lower prices from the demand curve that was derived in Figure Ba* A demand curve built up from an indifference map with flat pricing and containing both income and substi­ tution effects is designed to describe alternative actions of the individual consumer# It cannot be used to describe successive actions of the individual. Morgenstem says that the only way the original demand curve has meaning after one alternative transaction has taken place is through a reconstitution of the demand curve# He claims an individual *s demand curve has been reconstituted when* (a) either a new income payment and conse­ quently a confirmation of his previous expenditure plan has reproduced a future demand curve (identically or with modifications ), or, Cb) his expenditure plan has been modified and a new demand curve (shich may or may not have the original shape) is set up which describes his immediate future intentions in the market under consideration . * * An individual demand curve of one variable, then, no matter what its shape, is valid as it stands, only for one single use, i.e. for one transaction# G Sibld.. p. 171. 60 Only If other prig** are lower than the alternative price can there be other tr&nsaotione* lorgenstern raises the point that price elasticity of demand m a t be considered more carefully when the temporary nature of the demand curve la considered. Elasticity concepts require an unaltered demand curve. He indicates that the variations that elasticity is supposed to characterise destroy the very foundation on which it rests. His criticism of demand points out some very important questions that have either been neglected or misunderstood in many studies of demand. Price Discrimination Involves Successive Action Special emphasis on some of the characteristics and properties of a consumer*# demand curve for fluid milk based on uniform or flat pricing is made to show that many of these features become meaningless in considering pricing policies that involve price discrimination. Price discrimination between different quantities for the same individual is predicated upon the notion that sequential action on the part of the consumer is important, The effectiveness of this type of pricing policy rests upon the fact that the consumer is influenced by the marginal expenditure for an additional unit. The average 6X price per unit for ell units purchased tends to be a secondary oonslderatioa. à consumer’s marginal outlay for a commodity involves considering expenditures In terms of successive ©vents. It is important* therefore# to try to formulate some means of describing this phase of the consumer’s behavior* In considering these successive steps it is assumed that the demand curve has not reconstituted itself in terms of Morgenstern*8 requirements* Instead# an inquiry will be made into what happens to the original demand curve. For example# if an Individual makes a transaction at one price and quantity, it is pretty well agreed that all quantities at a higher price become meaningless. Even the original demand curve based upon uniform pricing is not descriptive of quantities demanded at a lower price. If the demand curve is not reconstituted, the portion of the demand curve below the point where the transaction was made must be greatly modified* Some explanation as to the modifications that must be made in the demand curve predicated upon uniform pricing below the point where a transaction takes place is needed for determining the feasibility of quantity price discrimination. Morgenatern refers to this as an individual’s derived reaction function. He describes se the reaction function m follow#* The additional demand in case of a price fall, will be the quantity %14rl which can be bought at the new, lower# price for the amount ZX. • ^U+-lFiH"i tiPi* When A $ o there are no transactions; A. > 0 is the amount that may be spent for additional units. In words# A i# the difference between intended outlay at the lower price Pi4rl and the outlay that has actually occurred at the price Pi. Repeated applications will yield a series of what m y be called the individual’s (short run) derived reaction functions.^ He points out that it would be convenient to call them derived demand curves since they are new demand curves with all the necessary properties# but the term is frequently used for indirectly demanded goods* Morgenstern apparently determines the difference between the intended outlay at the lower price Pi -hi and the outlay that has actually occurred at the price ^1 on the assumption that the consumer has the opportunity of making the two alternative purchases on the basis of uniform pricing for all quantities. This gives slightly different results from the difference between the expend" iture that actually occurs for price ^i and the intended expenditure at price ^ 1 + 1 which holds for only the additional quantity purchased at the lower price rather than for the entire quantity* 9?bld.* p. ITS. 63 Im terms of m Indifference map, esse would seem to be shorn by two separate opportunity lines for the two prices. As far as quantity price discrimination is coaoerned, it would seem to have more meaning if the opportunity line consisted of one line in which the slope changed to indicate the high and low price for the quantities taken at the respective prices. Korgenstern’s situation seems to imply that when the price elasticity of demand is inelastic there would be no additional transactions# Indifference curve analysis reveals that as long as there are diminishing marginal rate* of substi* tut ion# transactions can take place via quantity price discrimination involving additional outlay as long as the price is greater than mro. riving a Discrimination Demand Ourve. fr.oA.. . IndifferenceIw Much has been written about demand involving perfect or flat pricing. However» demand theory involving intra- consumer quantity price discrimination and the monopolistic purposes of this study quantity price schedules involving quantity price discrimination will be considered as a special demand curve which will be denoted by discrimination demand curve if & distinction is needed for clarity* 64 practices that It Involves# has not reeeived the same amount of attention* Most of the literature neglects to explain or justify the use of various methods of price discrimination that is so prevalent in modern day business practices. The increasing and successful use of discriminatory pricing and selling methods suggests that such activities have a logical and important rationale in our economic system. It is beyond the purpose or scope of this study to add much of a constructive nature that would narrow the gap which is required for describing and analysing this phase of economic activity. M attempt will be made# however# to explain some of the problems involved in price discrimination with the use of some of the tools that have been discussed in the preceding pages, ■Bculding states that perfect price discrimination# if such a practice were possible, involves shifting the consumer on the same indifference curve* 11 In other words# the opportunity line and an indifference curve become the same thing* The underlying assumption is that after the consumer makes a purchase end reaches an equilibrium ^Kenneth B. Boulding# Economic Analysis. New York? Harper and Brothers Publishers# 1948, p* 768. m pétition for that particular price and quantity, the price for the next euoceedlng unit Is lowered as the consumer’s marginal rate of substitution falls, which entices the consumer to make the additional purchase. If the price shading could be accomplished with precise accuracy to correspond to the falling marginal rates of substitution, the satisfaction or marginal utility of the money given up in payment for the commodity would be exactly compen­ sated for by the gain in the marginal utility from the product purchased* In terms of utility or satisfaction, the consumer is no better off through making the purchase# nor is he any worse off, since he remains on the same indifference curve, although another unit of the commodity has been placed in the hands of the consumer and he has given up a part of his income for it. This proposition can be illustrated with an indifference diagram. In Figure 3 the axis and indifference curves have the same meaning and are drawn similar to those dt Figure 8. In this case# however, another Indifference curve is drawn connecting with point P. This curve (PY) Indicates that there ere quantities of milk and income which are just equal to the satisfaction that the consumer enjoys at the position P where h& has all of his income and no milk. Now if perfect price discrimination were 66 Milk E5 M 20 10 05 Milk FIGURE 3 (Top)aiid 3a. Derivation of a Consumers' Discrimination Demand Curve under Perfect Price Discrimination 67 possible» the eoaewmef oould be shifted from point P down^ ward along curve PY by offering the consumer successive marginal units of milk at a price that is the same as the falling marginal rates of substitution of milk for money» These prices represent the maximum successive bid# that the consumer would be willing to pay for a given quantity of milk assuming that the individual moves downward and to the right along this indifference curve* In to ms of hicks * analysis the curve contains substitution eff ects only since the consumer stays at the same level on his scale of preference, % l n g the graphic techniques used in Figure Sa, a modified discrimination demand curve can be derived from this single indifference curve* Since the opportunity line or price line and the indifference curves are exactly the same under perfect price discrimination, the price line becomes a series of successive prices, each one slightly lower than the previous one* let a slightly extended price line corresponding to 86 cents per quart# having exactly the same slope as PQ in Figure 8# be fitted so that it is tangent to indifference curve Pt at E* This indicates that by practicing perfect price discrimi­ nation from point P downward along PI, the consumer la willing to give up PD of his income and the total quantity m ùt milk taken would be OF. m This point can be construed forming one of the points (E) on the discrimination demand curve shown in Figure 5a where 85 cents represent* the price and OF the quantity. The same procedure is undertaken in locating points J and H in Figure 5a from Figure 5 for 80 and 15 cents per quart, respectively# A* before it is assumed that a series of such points join to form a downward sloping discrimination demand curve# &wming_()H ]P0i,i(:]:a23 :I3rSF0I,VIB8 QiadLNT][]% iMBULCiE I)][G{;2lI]W:[BLA3r][CW( Cases qf Price Elasticity of Demand the price elasticity of demand for fluid milk is a much disputed point. Many studies have been made which indicate that changes in quantities purchased are not very responsive to changes in price. On the other hand, some people in the industry believe that demand for milk is relatively elastic, at least for some income groups, and recommend pricing policies based upon this belief. To say that little is known about the price elasticity of demand for fluid milk, in general or for particular market situations, is probably an overstatement of fact* The demand for a particular market is an aggregated demand for the individual consumers within that market. The tastes# preferences, desires, resources, etc., of individuals making up the market vary greatly, making aggregate market demand as well as Individual consumer *s demand difficult to analyse or explain. As has already been shown, the slope of the demand curve is important in initiating quantity price discrimination, since there 87 Aearns to be no practical way of determining precisely the price elasticity of demand fey empirical investigation or data, some cases will fee presented that might describe, with limitations, some of the situations that might fee encountered with various consumers, Accepted definitions of price elasticity of demand require that the individual consumer increase his total expenditure with the fall in price of a particular com** modity, if his price elasticity of demand is greater than unity. That is, a change in price produces a greater proportional change in quantity purchased. If the price elasticity of demand is less than unity, the consumer's total expenditure will decrease even though some additional quantity of the commodity is purchased* If the price elasticity of demand is unity for the particular consumer, no additional total expenditure will fee made for the additional quantities purchased due to a decrease in price. These measures of price elasticity are very general and do not give much information about the nature of the demand curve. They do, however# constitute the breaking point which involves different pricing and marketing techniques. The general oases of elastic and Inelastic price elas­ ticity of demand will fee considered for fluid milk. The case of unity is a special case that will fee omitted in 88 this analysisi since the results will be at least implied from the elastic and inelastic situations. :»rjLCil33jK Some broad generalisations about pricing policies and patterns are warranted from the indifference technique for the elastic and inelastic cases. fluid milk is shown in Figure 8. The elastic case for The axes are assumed to have the same meaning as in Figure 8, The indifference, curves are drawn to illustrate the case where the price elasticity of demand for fluid milk is elastic. The in­ difference curves under such a situation are very flat indicating that Income and milk are good substitutes for each other. The slope of the price line PQ is assumed to represent the price of milk before the price change, equilibrium position is reached at E, An At this position PB income is given up and the quantity of milk purchased for this income Is indicated by CF. Suppose now# that the price of milk is reduced on a flat basis to a price as indicated by PG, The new price line PG is tangent to indifference curve LI at point H. In this case because of the fall in the price of milk, total expenditures are increased from PD to PC or DC and the quantity of milk purchased is Increased from OF to OH 89 a § a Milk FIGURE 8. Indifference Curve Analysis When the Price Elasticity of Demand,is Elastic 90 ©3P 1*1* With this given scale cf preference and under the price relationships shown, It can be said that the price elasticity of demand for milk is elastic* It can be seen that the consumer is on a higher in~ difference curve* purchases In order to get to that position, he an additional quantity of milk and he increases his total expenditure for milk* ceptable to the consumer* This situation is ac­ The dealer or the industry’s position can also be summed up in a similar manner* As long as the increase in the industry’s receipts (DC) is greater than the cost of producing the additional quantity of milk (Fi) the dairy Industry would also prefer position it* If this were not the case, position £ would be preferable,-assuming that S is a profitable position. The Elastic Case with Discriminatory Pricing The question that needs to be answered for purposes of this study is what would the results be if quantity price discrimination were practiced. The answer to the question, of course, depends upon the pattern of dis­ criminatory pricing. If it Is assumed in Figure 8 that price discrimination is initiated after the equilibrium position of E is attained, then for comparative purposes a price line (£J) parallel to PG can be drawn from point S. 91 Thi® line le tangent to m J. Indifference curve KK at point This would mean that under this pricing policy the consumer would increase hi# purchase of milk from OF to oa or PB. A comparison between a flat price reduction from the price indicated by PQ to PG and a reduction in price involving quantity price discrimination at the same price can now be made* The consumer would be on a higher in­ difference curve with flat pricing. He would increase his expenditure considerably less (DG compared to 0B) and the quantity of milk would be considerably increased (FH as compared to FM). Under this particular pricing pattern the consumer would definitely prefer a flat price reduction. The dealer’s or the Industry’s position can also be summarised. If the marginal revenue (DC) produced by selling quantity FI is greater than the marginal cost of producing and selling FI, then position H is the preferred position for the industry. However, if position B is profitable, while H is not# then as long as the marginal revenue DB is greater than the added cost of producing and selling FM, position J is preferable to B for the dairy industry. It is possible that J could be a profitable position while H is unprofitable. The 9S revenue received from the consumer represented by DB for the purchase of quantity FM la much greater than the revenue represented by DC for the purchase of a greater quantity FM» The above results suggest the point that even if the demand curve for milk were elastic, there might be cases where it would be profitable for the industry to attempt a program of increasing sales through quantity price discrimination, where a policy of flat price reduction would be unprofitable. If quantity price discrimination can be accomplished by some means without too.great a cost to the industry, both in terms of mechanics of any particular scheme, as well as loss of goodwill on the part of the consumer, circumstances are very possible where quantity price discrimination would offer ad­ vantages to both the consumer end the industry. The consumer stands to gain since he is placed on a higher indifference curve with discriminatory pricing than with a policy of price maintenance. In order to get to the higher Indifference curve the consumer is willing to give up an additional part of his income for an increased quantity of milk. The dairy industry would stand to gain since it might be possible for it to increase its 93 met revenue over that earned from a policy of holding the prie# cometamt in vie# of the seasonal fluctuations Im production. lot only Is this me# possibility of profit importent to the industry from a monetary point of vie** but perhaps even more important, a policy of quantity price discrimination might be an effective *#y of moving surplus fluid milk into a fluid market than would otherwise be the case - for ex&ople, where it find* it# way into process dairy product*. HoM# ,a $Wi!^ure of Income Effects A* far as the consumer Is concerned the desirability of particular patterns of pricing can be measured by comparing their effect* on the height or level of the indifference eurves involved# Glace the level of the indifference curve can be used as a measure of income effects in comparing various pricing patterna# it can be Said that those pricing,patterns that offer the greatest Income effects are preferable to the consumer. In the comparison of flat pricing and quantity dis­ criminatory pricing presented above, it was shown that flat pricing was preferable to the consumer for the particular pricing patterns discussed. It can be shown, 94 however, that certain patterns of quantity price discrimi­ nation can allow as much, or more, Income effects than those offered to the consumer under the pattern of flat price reduction indicated in Figure S» hut never as much as if there had been a flat price equal to the weighted average of the discriminatory prices. This can be shown by drawing a line (SS) tangent to indifference curve IL and connecting point 1* Price line IS represents a con­ siderable reduction in price as compared to price line PO. In this case both a flat price reduction and discriminatory pricing are equally acceptable to the consumer, since they place him on the same indifference curve* One important point should be noticed, however, even though in this case the income effects are comparable, the substitution effects indicate that the consumer would, be willing to taka a greater quantity of milk. This is shown in the diagram by comparing FM with.FT# Any line flatter than BS would even allow a greater income effect than alterna­ tives shown by price line PG or ES as long as it started at point £. The point is made merely to indicate that in some circumstances Income effects can be considerable under price discrimination. In reviewing the case in Figure 8 it is possible for position B to he more profitable for the industry 96 % h m Hi although It is not apt to be true. Getting to position S involves a considerable increase in quantity and in expenditures on the part of the consumer. If 6 were more profitable than H it would perhaps be possible for the industry to establish another flat price reduction and put the consumer on a higher indifference curve, resulting in a position that would still be more profitable to the industry than point 5# Even if a policy of flat price reductions was not preferable to this particular pattern of quantity price discrimination, it is almost certain that other patterns of quantity price discrimination would be preferred by the industry* In all probability the industry would attempt to pursue these other alternative patterns that might maximise their net revenue, instead of being concerned with placing the consumer on the highest possible indifference curve. However, considerable income effects are possible under quentity price discrimination. Whether or not the pricing pattern of the industry would allow them is a matter that would be influenced by the particular market conditions, Substitution Effects in the Elastic .Case It has already been point out that when the price elasticity of demand is elastic the Indifference curves 96 &r® flat and have a ve$y gradual curvature* This means that milk la a very good substitute for money. In terms of an indifference analysis, the substitution effect becomes very important in any price reduction as a means of increasing the quantity purclmsed. In Figure 8 it can be seen that going from position E to J involves a relatively large Increase in quentity taken (FM), although the Income effect (II to KK) is rather small. Most of the increase in quantity taken is explained by the reduction in price on a discriminatory basis from that represented by PQ to M . The fact that substitution effects are so Important when the price elasticity of demand is elastic gives added weight to the argument that discriminatory pricing would be effective in increasing the quantities of milk purchased by those who are responsive to price change. A two-price dis­ criminatory pattern with a considerable spread between the two prices would not only take advantage of a large substitution effect, but would also be greatly supplemented by a considerable income effect that would further increase quantities purchased. 97 iUMMry or...the Elastic Case. Market demand for a partleular commodity Is the sum of the demand on the part of Individual consumers. If all individuals had am elastic price elasticity of demand for fluid milk, the following summary would seem to be true under actual market conditions and practices. Either a policy of flat price reduction or quantity price dis­ crimination is preferable for the consumer to a policy of holding prices constant as production fluctuates in response to seasonal factors. As far as the industry is concerned one or the other 1.S preferable as long as the marginal return for the added qu entity sold is greater than the marginal cost of producing these units. In some conditions a flat price reduction as a means of selling increased quantities is preferable for the Industry. This is apt to be the case where the costs of discriminatory pricing are very high* On the other hand, If costs involved In price discrimination are not excessive* it is very possible that there are cases where quantity price discrimination would be preferable to a flat price reduction in terms of profitability to the industry as a means of expanding quantities sold. 98 If the market demand curve for fluid milk is elastic, a vote cam be registered In favor of at least seriously considering all the possibilities of seasonal quantity price discrimination, since a policy of flat price re­ duction is not looked upon with favor by the industry. If some program of quantity price discrimination can be found that is effective, the fluid milk industry would be more profitable and the consumer would be able to make a better disposition of his resources than he is able to do under a policy of holding the prie® at high levels during seasonal increases in fluid milk production. The Inelastic Case with Flat Pricing In Figure 9 the case where the price elasticity of demand is inelastic is presented# The axis and the flat price lines for a policy of flat pricing have the same meaning as in Figure 8. In this instance however, the indifference curves have been drawn to show the case where the price elasticity of demand is Inelastic, In this situation the indifference curves are not nearly so flat as in Figure 8, which produces the result that a considerable reduction in the, price of milk leads to a very small increase in the quantity purchased. 99 a Q F M NQY G Milk FIGURE 9. Indifference Curve Analysis When the Price Elasticity of Demand is Inelastic 100 T W regmlrements foj? the inelastic case are that although the total quantity of milk taken increases# the total expenditure on the part of the consumer decreases with a fall in the price of milk. Figure 9* This can he seen in Position B Indicates an equilibrium point where PD indicates the amount of income given up for the purchase of the quantity of milk shown by OF. If the price of milk is lowered to a price indicated by PQ, the new equilibrium position is reached at ii. At this point it can be seen that because of the flat reduction in price for milk, the consumer has increased his con­ sumption of milk from OF to 01 or FH, Expenditures on the other hand have decreased from PD to FB or by an amount equal to BD« In other words# the increased quantity taken has not been sufficient enough to compen­ sate for the fall in price and as a result total expendi­ tures have decreased. The more inelastic the price elasticity of demand, the smaller the quantity taken with a fall in price and the greater will be the decline in total expenditures on the part of the consumer. The Inelastic Case with Discriminatory Pricing suppose now that after the equilibrium position at B is reached, a policy of quantity price dlscrlmlrmtion 101 is initiated. Let the price charged for the additional quantity sold be equal to the price represented by price line PQ. to m this is shown by price line IE, which is tangent indifference curve at J. At this equilibrium position with this pattern of discrimination, the quantity of milk taken has increased from OF to 01 or FM, and the expendi­ ture has increased from PD to PC or DC. Other variations from these results are possible depending upon the reduced discriminatory price. For example dotted price line FT represents a considerably lower price than that indicated by PO. It is tangent to a higher indifference curve than that shown by position J. It represents greater additional quantities of milk taken and also a greater expenditure on the part of the consumer. Summary Statements for the... Inelastic Case Enough has been shorn for the ease where the price elasticity of demand is inelastic to justify some con­ clusions. Probably the most obvious generalisation is that with a price elasticity of demand that is inelastic both for the individual consumer and the market, it is never profitable for an Industry to reduce price on a flat or uniform basis in an attempt to increase quantities 108 sold. Some costs are always Involved In making these additional quantities available to the consumer. However, under the inelastic case there is no payment to cover these additional costs, sine© total revenue is less for the increased total quantity than it was for the original quantity# If an Industry or a firm has any control at all over its pricing policy, it will never decrease price on m flat reduction basis in order to sell additional quantities of the commodity# If the industry or the firm doe® not have control over its pricing policy, the incentive is present to do all in its power to gain control# As far as the consumer is concerned a flat price reduction is very likely to place the consumer on a higher indifference curve unless the comparison la made for a flat price reduction that is small with a considerable price reduction on a quantity discriminatory basis# It is possible, if the indifference curve does not bend too much, that quantity price discrimination at very low prices could place the consumer on as high an indifference curve as a moderate flat price reduction. Such a situation, however, would generally involve selling such large quantities for such a low return on the part of the industry, that other more suitable alternatives would probably be pursued. X03 It is possible, and under large flat price reductions it is very probable, that the consumer*s indifference curve might bend upward before reaching a horizontal plane for a given equilibrium point Ca.g*, E) so that it would be impossible to place the consumer on as high an indifference curve with quantity price discrimination# even if the comiodlty were given away free as represented by a hori­ zontal price line. In the inelastic case, if the consumer is offered the alternative of a flat price reduction all is well and good for him. If he is not# and there will be every incentive on the part of the Industry not to make this alternative possible for the consumer, then under present pricing practices for fluid milk, he must be satisfied by staying at the original equilibrium position (e.g.# E). It is the case where the price elasticity of demand is Inelastic that policies of quantity price discrimination are apt to offer the greatest potential possibilities in the pricing of fluid milk. Although there may be con­ siderable justification in some instances for quantity price discrimination where the price elasticity of demand is relatively elastic, the case is not apt to be as clear 104 In reference to the dairy industry, most individuals concerned with marketing of fluid milk maintain that the price elasticity of demand is relatively inelastic. If we assume that this is true, and there are many empirical data to Indicate that it is true, then a policy of holdiîîg the price at a high level in spite of seasonal fluctuations in production Is justified from an industry point of view. If the Industry does maintain its price, then the consumer is in the most unfavorable circumstance of the three alternative positions presented la Figure 9. The alternative of a flat price reduction with the inelastic case is not a satisfactory position from the dairy industry *s point of view. If, for analytical purposes, we assume that the positions striven for must offer some gains or benefits, not only to one but to both the dairy Industry and the consumer, then the proposition of a flat price reduction can be discounted. The choice, therefore, remains between the policy of holding-theprice or a policy of quantity price discrimination. In terms of Figure 9 the choice is between position E and J. consumer Is clearly better off at position 1. If pattern of quantity price discrimination allows considerable income effects, J will be on a considerably higher indifference curve than I. 10§ In order to get to a position represented by J, the consumer has given up an additional part of his income, which he is willing to do in order to attain a higher degree of satisfaction. A® far as the dairy industry is concerned, allowing the consumer the alternative of attaining a position represented by J, means supplying additional quantities of milk in exchange for the ad­ ditional income the consumer is willing to give up. As long as this additional income from the consumer, or marginal revenue to the industry, is greater than the marginal cost of producing this extra milk, position J is mutually advantageous for both the consumer and the industry* limited Substitution Effects in the Inelastic Case It should be emphasized# however# that any two-price system of quantity discrimination involving the case where the price elasticity of demand is inelastic has little chance for success unless the spread between the two prices is very great. In the inelastic case the in­ difference curves have a much sharper bend indicating limited substitutability between money and milk. This means that for a given price reduction, the substitution effect is very small. This is shown in Figure 9, The 106 prie® for milk represented by F0 is a considerable reduction in price as compared to that represented by PQ# Even so, the substitution effects of this flat price reduction are rather small. This is shown by the arc WH where UV has been drawn parallel to PQ* The substitution effects Wd on the quantity taken is obviously rather small because of the rapidly falling marginal rate of substitution of milk for money. Because of the limited substitution affect of any two-price system, it Is important that the differential between the two prices be just as great as possible so that a large income effect can supplement the substitution effect in influencing the quantities purchased because of a discriminatory price reduction. It is only in the event that a considerable spread between the flat price and the discriminatory price can be affected, that quantity price discrimination has a fair degree of success in the inelastic situation as a means of increasing consumption of fluid milk. Borne Favorable Results of the Analysis So far, the analysis in this study has been primarily confined to the consumer. Some of the problems involved in pricing policies (when the price elasticity of demand is elastic and inelastic) have been presented. The results 107 lead to one of the very important points of this study. Contrary to the opinion held by many people* the results show that there might fee a place for quantity price dis­ crimination as a means of promoting the sale of fluid milk in some markets. It Is granted that quantity price dis­ crimination involves monopolistic practices. Discriminatory practices often lead to resentment and suspicion on the part of the consumer. It must also fee admitted that the administrative and promotional activities involved in intra-consumer discrimination are complex even if a satisfactory method of discrimination can fee found. There are reasons to believe* however, that discriminatory pricing would involve less monopolistic practices than are now feeing exercised through a policy of holding the price which is found in most fluid milk markets. Even though it may fee difficult to formulate and work out the details of a satisfactory Intra-consumer seasonal quantity price discrimination program* an effort should fee made to do so* if only on the basis that it is a sales technique that has some possibility of improving the marketing of a very important food item in some markets. OmPTER V ANALYBia REOONSIDBRED THE ABBUMPTIOM THAT THE MAROIMAl UTILITY OF MOREY 18 CORGTANT Aasumntlan in the Purchase of Fluid The anelyzle up to this point has been made with the assumption that there has been diminishing marginal rates of substitution for both money and milk. As the indifferenoe curves have been drawn so far, changes in the quantities of money* or milk, will affect the marginal rates of substitution between the two oommodities. Following Micks * footsteps, Marshall*s assumption that the marginal utility of money is constant was avoided in order to analyze the Income effect of various pricing policies and patterns. flicks points out that Marshall *s assumption that the marginal utility of money is constant is an ingenious simplification which perhaps has some validity as a special case in demand theory. 1 Marshall was well aware of the fact that the assumption that the marginal utility of money was constant applied to limited situations. ^ Hicks, On. Git., p. 87, 109 ii shown In the following quotation: But we did not allow for any appreciable change in the marginal utility of money; we assumed that it would be practically the same whether the early payments had been at a high rate or a low rate. This assumption is justifiable with regard to most of the market dealings with which we are practically concerned. When a person buys anything for his own consumption, he generally spends on it a small part of M s total resources; while when he buys it for purposes of trade# he looks to reselling it, and therefore his potential resources are not diminished. In either case the marginal utility of money to him is not appreciably changed. But though this is the case as a rule, there are exceptions to the rule.^ Marshall's assumptions may have a very important bearing upon the marketing of a product like fluid milk. For many consumers it is very possible that the usual purchases of fluid milk do not affect the marginal utility of money* It is possible that total fluid milk purchases constitute such a small part of the total expenditure that changes caused in the consumer's supply of money will not affect the marginal rate of substitution between money and milk. For these reasons it is well to reconsider the effects on the analysis, if it is assumed that the marginal utility of money is constant. Marginal Hate of Substitution Independent of Quantity of Money In Figure 10 money (or income) is shown along the y and milk along the x axis. The Indifference curves ® Alfred Marshall, Principles of Economics. Vol. 1, London, MacMillan & Co., 1890, p. 395, 110 mik .25- ^ .10 Milk FIGURE 10 (Top) and 10a. Derivation of a Consumer’s Demand Curve % e n the Marginal Utility of Money is Constant Ill have b$#n û r m n parallel in a vertical direction; that i@> at any given qumtity of milk the slopes of the in­ difference curves» or the marginal rates of substitution» are the same regardless of the quantity of money* This corresponds to Marshall*® assumption that the marginal utility of money is constant# &hen the marginal utility of-money is constant, the marginal rat© of substitution depends only on the quantity of milk held by the consumer# It is not affected by the quantity of money* Such a situation Implies that the total quantity of money held by the consumer is so large that changes in his holdings of money have no effect on his willingness to part with it for fluid milk* The consumer *s demand is influenced only by his willingness to obtain more milk» not by his willingness to give up or acquire more money. Boulding points out that the condition that the marginal rate of substitution should be independent of the quantity of money is broader than the Marshallian assumption in the following statement: The marginal rate of substitution could be independent of the quantity of money even if the marginal utility of money changed (presumably fell) with increase in the quantity of money, provided that the marginal utility of the commodity changed in the same proportion. Fortunately» however, the indifference curve 118 technique enables us to escape from this grave restriction in a way that the old marginal utility snalysis did not permit»* uurve Marginal Utility of Money With the Indifference curves drawn In Figure 10 to conform to the assumption that the marginal utility of money is constant, a demand curve can be derived for fluid milk under these special circumstances, Suppose price line PQ is assumed to represent a price of 85 cents per quart for fluid milk and is tangent to indifference curve II at E» This indicates that the consumer is willing to purchase quantity OF of milk and give up PD dollars for it# This Information can be transferred to Figure 10a and forms one of the series of points making up the conventional demand schedule* Price lines PO and PR are assumed to represent prices for milk of 80 and 15 cents per quart respectively. From their points of tangeney, quantities are specified that can be transferred to Figure 10a which form other alternative points on the demand curve. In such a manner a series of points can be established that form the conventional demand curve corresponding to the one derived in Figure Ea. ^ Bouldii'ig, Go. Cit», p. 764. 113 of Demand Curve When Marginal Utility of iheii a discriminatory demand curve is derived from the same indifference diagi^am entirely different results ere forthcoming from those found under the assumption that money had diminishing marginal utility for the consumer. Indifference curve FT in Figure 10 corresponds to FT in Figure 3, It represents the curve along which it is theoretically possible to practice perfect price discrimination. However, since for any given quantity of milk, the entire family of curves have exactly the same slope, moving down along FT in successive steps by lowering the price after each equilibrium point is reached, results in the consumer taking the same quantity under perfect price discrimination as under flat pricing. This can be shown by considering tangent ST which is drawn parallel to PQ, which was assumed to represent a price of 25 cents per quart for milk. Moving down along curve FT via a policy of perfect price discrimi­ nation results in the seme quantity of milk being taken by the consumer when the price reaches 28 cents per quai*t as under flat pricing when all the milk Is sold at 25 cents per quei*t. Since it has been assumed that the marginal 114 rate© of substitution is independent of the quantity of money, for a given quantity of milk all the oui'ves have the same slope and thus result in a single marginal rate of substitution curve which has been shown as a demand curve in Figure 10a, Ho matter what the pattern or system of prices, the demand curve derived remains the same, since the marginal rate of substitution is the seme for all curves for any particular quantity of milk. A pattern of flat pricing at 86 cents per quart to point E and then the initiation of a discriminatory price of 20 cents per quart to point U (EU drawn parallel to PO, indifference curve not shown) results in the consumer taking exactly the same quantity of milk as he would when e flat price of 20 cents per quart were charged for the entire quantity CM, The demand curve in Figure 10a remains exactly the same under both pricing alternatives. Income Effects do not Affect Quantities Purchased In the previous analysis #ien it was assumed that the consumer had diminishing marginal utility for money, it was found that income effects had a definite influence on the demand curves that were derived from the various indifference curves. According to the procedure established by Hicks, the height or the level of the indifference curve 116 was used as a measure of the income effect. It was found that the greater the income effect foynd under various patterns of pricing the more elastic was the demand curve, assuming diminishing marginal rates of substitution. When it ia assumed that the marginal utility of money is constant, it can be seen that income effects do not alter the shape of the demand curve at all. From a practical point of view this means that the consumer does not buy more milk when his income is increased if the price of milk remains the same as it was before his Income was increased. On the other hand, it also means that when milk is priced on a flat or uniform basis, the fall in price leads to a quasi-increase in income which is not used to purchase more milk. The increase in purchases because of a fall in price is attributed entirely to the substitution effect when it is assumed that the marginal utility of money is constant. .Pr#errM Fatterns of JPrislng Although our analysis shows that several patterns of pricing may lead to the consumer purchasing the same quantity of milk, it can be seen that they have different effects on the consumer's welfare as measured by the height of the indifference curves Involved. Similarly, 116 some pat t e r m of pricing are more acceptable than others to the dairy industry even though the same quantity of milk is involved. This can be shown by compai'lng the results of s flat reduction in price to a reduction in­ volving discrimination. At point S with a flat price of 86 cents per quart it was found that the consumer purchased OF quantities of milk and gave up PD dollars for it. .ïith a flat price of 20 cents per quart represented by PO the quantity of milk is increased from OF to OM or FI and the expenditure is decreased from PD to PC or CD# It is obvious that with the indifference curves as drawn in Figure 10, the elasticity of demand is less than unity. Suppose that after the consumer reaches the equi­ librium point at 1, he is offered the opportunity of purchasing additional milk at 20 cents per quart repre­ sented by price line EU, rather than a flat price reduction of 20 cents per quart. In this instance the consumer reaches an equilibrium position at U indicating again that the quantity taken under this two price system would be OM. However, in these circumstances the expenditure on the part of the consumer is increased from PD to PA or DA. It is readily apparent that position J will never be an opportunity for the consumer if the dairy Industry 117 ©an avoid it* since it involves a loss for the industry as compared to position E. M As long as the marginal revenue from the sale of FM is greater than the cost of producing and marketing this quantity of milk position U is preferable to both the consumer and the dairy industry. The consumer is not nearly as well off at position U as at J, but U is more desirable position for the consumer than S. Nummary Statements When the Marginal Utility of Money is Constant Enough has been shown for the consumer whose marginal utility for money is constant to warrant some generalizations. For a given price, whether the alternative is successive action involving discrimination or a flat or uniform price reduction Involving alternative action, the quantity of milk taken is exactly the same. Total receipts to the dairy industry are always greater for the given quantity and price when price discrimination is practiced rather than a flat price reduction. This applies when the price elasticity of demand is elastic or inelastic. As long as marginal revenue is greater than marginal cost price discrimination will be preferred by the industry. Since the same quantity of milk is always Involved at a given price the consumer will always be better off under a 118 flat price reduction. In the event that a flat price reduction is not offered to the consumer, any pattern of price discrimination (except perfect price discrimi­ nation) will be preferred by the consumer rather than a policy of holdlng-the-priee. If the results suggested toy the analysis are true, then the case for price discrimination when the marginal utility of money is constant has some additional advantages over the results suggested by the analysis wtien money was assumed to have diminishing marginal utility, since the demand curve remains unchanged regardless of the pattern of pricing, the use of price discrimination becomes a more Important marketing technique as a means of increasing consumption of fluid milk during the period of seasonal Increases in production. Marshall*s assumption that the marginal utility of money is constant may very well apply to some consumers in their purchases of fluid milk. From the results shown by our analysis no new blocks are thrown in the path of a policy of price discrimination toy Marshall's assumption. Indeed, it is very possible that the case for price discrimination becomes more water-tight under the assumption that the marginal utility of money is constant. 119 The analyses presented by this study raise some interesting points or discrepancies found in usual theoretical analyses or writings on theory that deserve further comment. In regard to Marshall, Hicks makes the following statement % It will appear in what follows that this is actually what the constancy of the marginal utility of money did mean for Marshall; not that he really supposed that people's demand for commodities do not depend upon their Incomes, but that in his theory of demand and price he generally neglected the income side.4 From the analysis undertaken in this study, by using rough approximations, a consumer's demand curve was derived for both the situation when money was assumed to have constant marginal utility and when it was assumed to have diminishing marginal utility. In the situation where money was considered to have diminishing marginal utility income effects had a definite influence on the shape and slope of the demand curve, (see Figure 3) In these circumstances a discriminatory demand curve was derived ^ Hicks, Op. Git.. p. 27. 120 predicated on aubstltutloji effects alone and It was f o m d to be steeper than the curve containing both Income and substitution effects. Although this derivation ignored income effects entirely* this is obviously not the situation that Hicks,* refers to, although it meets his requirements of neglecting the Income effect. When it was assumed that the marginal utility of money was constant, It was found that the demand curve based upon flat pricing was exactly the same as that for perfect price discrimination (Figure 10). the ease to which Hicks refers. This would seem to be In this case a demand curve derived only from substitution effects is unaltered by any Income effects that may be incorporated into the curve. It seems certain that Marshall allowed for Income effects in his demand theory* but because of his assumption that the marginal utility of money was constant, they did not offer an incentive for the consumer to Increase or decrease purchases. This point is made, not because Hicks has misinterpreted Marshall* but because it might help some to see what is Involved in Marshall's theory of demand and price. 181 maoed. on Analysis by Diminishing Marginal MSSzMlM^z It is often the practice, especially In analysing monopolistic competition, to use a given demand curve both for alternative and successive action. This is especially true in trying to arrive at equilibrium positions for duopoloy* oligopoly, etc. Generally the analysis involves actions that are undertaken at the same or immediately following moment of time so that there is no interval of time to allow for Morgenstern's reconsti­ tution of the demand curve to the original position. From Figure 10a it can be seen that if money is considered to have constant marginal utility some steps of both alternative and successive action can be analyzed by using the same demand curve as long as the movement is downward along the curve. In the circumstance that money is considered to have diminishing marginal utility the common use of a single demand curve to describe both alternative and successive action is no longer tolerable. In going from procedures involving flat pricing to discriminatory pricing the average revenue curve will always have a kink at the point where discrimination is initiated. Often this kink and its effect on marginal revenue is Ignored in theoretical analysis. In many 128 cas®® the demand curve becomes the average revenue curve under policies of flat pricing and, without considering any change in its shape, it is used as a marginal revenue curve under discriminatory pricing. The folly of such an analysis is emphasized when one considers the nature of a demand curve for price discrimination Involving only substitution effects and one for flat pricing consisting of both income and substitution effects# Consumer's Surplus Hicks claims that the doctrine of consumer's surplus has caused more trouble and controversy than anything else in Book III of Marshall's Principles.^ Without entering into this controversy, a few observations seem in order as a result of the proceeding analysis. Dupuit is given credit for conceiving of the idea of consumer's surplus as the triangular area bounded by the demand curve on the right, the price axis on the left, and the price line on the bottom.^ Marshall added his ingenuity to this concept by assuming this area measured the consumer's surplus with the limited assumption that the marginal utility of money ® Ibid., p. 36. G Ibid.. p. 36. 183 was constant# 7 Consumer's or buyer's surplus has been defined as the difference between what the consumer pays when there is a flat rate for all quantities and the maximum amount that can be extracted from him by skillful discriminatory pricing.® When it Is considered that the demand curve for jlat pricing and perfect price dlscrimlimtlon are identical under the assumption that the marginal utility of money is constant, Marshall's designation of consumer's surplus meets the requirements of Boulding's definition. It should be pointed out also that in terms of an Indifference curve analysis, this area is also an exact measure of income effect, when it is assumed that the marginal utility of money is constant# This can be seen in Figure 10, where PY represents the curve for indicating Income effects for perfect price discrimination and KK for flat pricing for quantity OM at a price ratio represented by the slope of line PG. This is another indication that Marshall was concerned with income effects, although it did not have any influence on quantity taken# When it is assumed that money has diminishing marginal utility, an entirely new situation arises. It has been shown (Figure 3) that flat pricing result© in Alfred Marshall* « p. 648. ® Bouidlns, Op. at... p. Bfô. X24 a demand curve that is entirely separate and distinct from a discrimination demand curve that is based on perfect price discrimination which represents the rsaximum amount that can be extracted from a consumer for a given quantity of a commodity. Neither demand curve can be used to get a measure of consumer's surplus. It has been shown that flat pricing is only valid for any one given point. As soon as a transaction occurs at a given point, all the other points become meaningless. It, therefore, makes no sense to consider the triangular area as a measure of consumer's surplus. The demand curve derived from substitution effects alone does represent the maximum amount that can be extracted from the consumer for any particular quantity of the commodity. However, this curve is based upon perfect price discrimination and involves a series of successive price cuts where a given additional quantity is taken with each price cut. When this demand curve is bounded on the bottom by a straight price line to form the triangular area, it means that a policy of flat pricing Is in force. A demand curve based upon perfect price discrimination has no meaning for a policy of uniform pricing* In other words the quantity indicated by the intersection of the price line and the demand 125 curve Itself, Is not indicative of the quantity that the consumer would be willing to take at that flat price. Neither curve gives the information required to determine consumer's surplus as it has been defined. It is also interesting to note that In neither case is the triangular area an indication of Income effect. About all that will be said about the Income effect is that when the income effect is added, to the substitution effect it does influence the quantity of commodity that the consumer will purchase because of the quasi-change in income. CHAPTER VI PRICE OIGCRIMIRATIOB AND THE THEORY OF THE FIRM In the preceding three chapters some theoretical aspects of individual consumer demand were analysed in considerable detail* Because of the impossibility of empirically verifying quantity-price relationships of consumers for fluid milk, a wide range of situations was presented with the thought that most consumers would fell somewhere within these limits. The next task is to consider some of the problems involved in aggregating these individual responses so that price quantity reactions can be postulated for groups of individuals constituting the market * Although Intra-consumer seasonal quantity price discrimination is feasible only for certain markets and certain individuals within that market* some notion is needed as to market-wide changes that might be occasioned by discriminatory practices. Morgenstern points out that aggregating individual demand schedules brings about many new problems.^ ^ Morgenstern, Do, Cit., p. 175. Izi the 127 first place he emphasizes that points on an aggregative curve aJE’® not completely alternative to each other. An aggregated, demand curve does not necessarily represent the reaponsea for a given number of people, so that some consideration must be given to successive as well as alternative action because of people entering and leaving the market. M d i t i v i t y of individual demand curve® is predicted upon the fact that demand functions for indi­ viduals are Independent of each other. Regarding this situation Morgenstern maintains that "current theory allow© no method of construction when various constituent up individual curves are not independent of each other. Evan in the case of milk it is conceivable that some people's purchases of milk are Influenced by what others purchase. Mergenstern further states that. Even if additivity is present, it is necessary to know the constituent parts in detail (i.e. Individual demand curves ) since exactly the same collective demand curve can be obtained in an Infinite number of way© from very different individual demand curves. The fact that it is generally deemed unnecessary to go behind aggregate demand curves reflects the assumption that it is Irrelevant to know the p a r ­ ticular way in which a demand curve arises (additive or not) from its constituent Individual demand curves.^ Z Ibid.. p. 175, “ Iblü.. p. 176. 128 The preceding analysis verifies the validity of these Statements. It is obvious that the limitations that were placed on individual consumer's demand schedules will also be placed on aggregated market curves. The problem of successive and alternative action has not been fundamentally changed through additivity# Original aggregate demand curves cmnnot offer information required for the formulation of programs of diecriminatory pricing without further transformation. The length of time for reconstitution may be somewhat different in the case of aggregated demand due to new people entering and leaving the market# This adds new complications since the pattern of the demand curve may be considerably altered after reconstitution because■of the various tastes and preferences of the different individuals Involved. In deriving a demand curve for individual consumers it was found that the negative slope of either the curve based upon flat or discriminatory pricing was a result of diminishing marginal rates of substitution# In the ease of aggregate demand curves no such assumption is needed if it be assumed that individual demand is additive. Differences in income and tastes between individuals would be sufficient alone to explain a negative sloping 1S9 demand curve. Some of the problems encountered In aggregating individual demand curves to obtain e market demand curve are pointed out to indicate some of the limitations that must be placed upon such a procedure. However, it will be useful to postulate an aggregate demand curve for fluid milk so that the analysis can be extended through the theory of the firm to explain some dealer and industry considerations Involved in quantity price'discrimination. 'Equilibrium of the Firm under Flat Pricing All dealers in the fluid milk Industry operate under some monopolistic conditions. One of these conditions is that there is a limit to the amount of milk that a dealer oan sell at any given price. Each dealer is faced with a sales schedule which shows how much milk be oan sell at each price# (For purposes of this study it is assumed that a sales schedule can also be formulated for different patterns of pricing# ) The sales schedule is an aggregated demand curve since it consists of individual consumer's demand schedules# Figure 11 illustrates a hypothetical situation faced by a firm. M is the aggregated demand curve which becomes the average revenue curve# M is the marginal revenue 130 25 .05 0 F M Milk F IGURE 11. Effect of a Two Price System of Price Discrimination on Quantity Taken 131 «Itiirv® while CG is the marginal cost curve* It will now toe readily seen that at point B marginal revenue is equal to marginal east which becomes the most profitable output ‘ for this dealer* At this position OF quantities of milk will be sold and the price is F F or E5 cents per quart* The total revenue is indicated toy OF % FF or the area OYPF* These results were obtained under uniform or flat pricing ; that is, all the individual consumers paid 85 cents per quart for all the milk that they received, iiow is this situation affected toy a two-price system of intra-consumer quantity price discrimination? It can toe assumed that point P represents the equilibrium position for one price* It is based entirely on flat or uniform pricing and is assumed to represent conditions found in the market in the absence of any discriminatory practices* After point P is reached, suppose discriminatory pricing becomes the policy for all quantities greater than OF* As has previously been shown, the point where discrimination is initiated mark# the point where the demand curve must undergo con­ siderable transformation to indicate the situation faced toy a dealer for particular patterns of discrimination. Portion FA of the curve loses its meaning as a pricequantlty schedule with the initiation of discriminatory pricing. 132 Saulllbrlîiis o f ,the Firm under Discrimination After point F is established, suppose another (discrimination) demand curve is aggregated on a flat price basis for all quantities greater than OB’* could be shown on a new graph, This but if one is careful in interpreting the meaning of the two curves and their relationship to the pattern of pricing, it is more revealing to place all the information on one diagram* FO represents a two-price discrimination demand curve assuming that point P establishes the one (higher) price at 25 cents per quart* 4 It corresponds to the consumer's demand curve that was derived in Figure 5. The various points on curve PD are then a series of alternative maximum bids for the quantities associated with each price under the assumption that quantity OF is sold at 25 cents per quart. It is based on a flat pricing policy for all prices under 25 cents per quart just as curve AP was derived under a flat pricing policy beginning with prices much higher than 26 cents per quart. ^ It is assumed that this portion of the curve represents only those individuals who have a purchase pattern that allows a practical program of discrimination f r o m the industry's point of view. 133 The next problem is to determine a point along curve PD that will establish the second (lower) price of a twoprice system of discrimination* Contrary to the analysis presented under many situations of discrimination PD does not become the marginal revenue curve. This would be the case only if perfect price discrimination were practiced and if this were so, PD would not indicate the quantity price schedule for perfect price discrimination. Gui've PD is now the average revenue curve and will have a marginal revenue curve (PO) to it just as AH was the marginal revenue curve to AIu The entire marginal revenue curve then follows a path along ABPO. It is apparent from the shift in the marginal revenue curve that if the marginal cost curve were unaffected the intersection of the marginal cost and marginal revenue curves at point B would not now mark an equilibrium position. If a general pattern of discrimination did not involve additional costs which greatly influence the marginal cost curve GC, then, the dealer could well afford to expand his sales beyond quantity OF since marginal revenue is greater than marginal cost after this point. However, it is readily seen that the influence of discriminatory pricing on the marginal revenue curve is an incentive to increase sales because of the possibility for further profit. 134 It is well to consider the special meaning that the diagram ha® because of introducing the practice of quantity price discrimination. It has already been pointed out that if uniform pricing were found in the market, point B would mark the equilibrium position* At this point the total revenue received from the sale of quantity OF is represented by the area under the marginal revenue curve (AE> Which is indicated by âBFO Which is equal to YFFO, since AIH * HBP. After point B is reached and quantity price discrimination is initiated, it is assumed that area ABFO remains unchanged. This implies t h a t 'the two- price system of discrimination does not in any way affect the quantities that would be purchased at the higher price represented toy FP. later this assumption will toe relaxed to explain other alternatives to price discrimi­ nation. F or the present it is assumed that the sale of any quantity greater than OF adds some revenue to the area shown toy ABFO. If it is assumed that the cost curve CC does not change when price discrimination is initiated, then, the equilibrium point for the second (lower) price of the two price system is established toy the intersection of the marginal revenue curve PG and the marginal cost curve at point E. This would mean, under the assumptions 135 pifeseîiteâ» that MI or 2X caats par quart would be the most profitable price to establish for the second (lower) price of the two*priee system. At this price of 21 cents per quart the additional quantity of milk indicated by FM would be sold. The total revenue received for only quantity FM is Indicated by the area lying under the marginal revenue curve or PEMF which is equal to JIMF. The analysis, so far, shows that because of the Inauguration of quantity price discrimination at 21 cents per quart quantity OM of milk is sold as compared to OF under flat pricing and the total revenue received for quantity OM of milk is the sum of area YPFO and JIMF. The profit to the dealer is Indicated by the difference between the marginal revenue and the marginal cost for each unit of the quantity. For quantity OF sold at 25 cents per quart, the profit can be shown by the area enclosed by ABC. The additional profit to the dealer for selling quantity FI under a quantity discrimination basis at 21 cents per quart is indicated by the area enclosed by PEE. This additional profit (PEB), then, is the incentive that the dealer or the Industry has for pursuing a discriminatory pricing program that would sell quantity FM of milk. 136 Mature...of....Mansinal Coat Curve under Discrimination % to this point It has been assumed that the marginal cost curve has remained unchanged throughout the analysis# This is very unrealistic because the nature of the cost curve will undergo certain transformations, depending upon the pattern of pricing, just as the average revenue curve was greatly altered with the initiation of quantity price discrimination# In analysing the marginal cost curve for the dealer# it is assumed that this curve reflects all the costs involved in getting the milk in the hands of the consumer. This includes the cost to the dealer of procuring the milk from the producer, all processing costs, as well as the distribution and sales costs involved for the various methods of distributing milk. In Chapters I and II it was pointed out that the difference between the cost to the dealer for fluid milk going into bottles and that going into manufacturing uses was very substantial in many markets» For some markets this difference has amounted to five cents, or more, per quart. The differential between fluid and manufacturing milk constitutes the underlying justification for a twoprice system of quantity price discrimination. It has been pointed out that one of the objectives of this study 137 was to determine whether this différentiel could not be used as a means of promoting th© sale of fluid milk as suah, rather than diverting it into the manufacture of lower use products as butter, etc. let it be assumed that there is a five cent per quart differential between the price of drade A fluid mine and manufacturing milk and that the dealer is permitted to purchase excess fluid milk at manufacturing prices, which is only to be sold on a quantity price discriminatory basis. Then, it is readily seen that this situation will greatly alter the cost curves for the dealer. It would mean that the marginal cost curve would drop by five cents per quart at the point where price discrimination was initiated. This is shown in Figure 12 where the aggregated demand curves have the same meaning as in Figure 11. GBId. becomes the marginal cost curve assuming the dealer can purchase fluid milk to be used In the discriminatory program at manufacturing milk prices# The differential of five cents per quart is indicated by BK. With the marginal revenue curve rising to point G and the marginal cost curve falling to point K after the equilibrium point is reached for the flat price at 25 cents per quart,it is 138 A 25 CO EH 20 t=> C3* O4 15 CO m o 10 .05 0 F N Q Milk FIGURE 12, Effect of Marginal Cost on the Price Differential in a Two Price System of Discrimination 139 readily apparent that the wide differential between the marginal revenue curve and the marginal cost curve offers excellent possibilities for additional profit for additional quantities of milk sold beyond OF, If it Is assumed that the dealer is willing to set the lower price of a two price system at a point where marginal revenue equal marginal cost* then the price will be determined by point I whei*© the price will be NI or 18 cents per quart and the ad« dltional quantity of milk sold under discriminatory pricing will be PN. In comparison to the analysis In Figure 11 the reduction In price for the quantities sold under discrimination is much more substantial. The differential of five cents per quart between fluid and manufacturing milk is great enough to bring about more favorable results as far as accomplishing the purpose of increasing the sale of fluid milk# M e e t s of Economies in Distribution on Marginal Cost Curve In Chapter II it was stated that any discriminatory pattern that was based only on the differential between the prices paid for fluid milk and manufacturing milk would seem to have very little chance for success unless the differential was extremely great and/or the price elasticity of demand was relatively elastic# Marginal 140 ûO$% curve CBKL indicates the effect on the quantity because of a sizable change in marginal cost# It should be pointed out, however, that the marginal cost curve has been altered only because of the differential in the dealers* buying price. If dealers really wanted to cooperate in promoting a program of quantity price discrimination, there are possibilities open to them that would favorably alter the marginal cost curve further for this course of action. It will be noted that the marginal cost curve has been drawn with a downward slope. This has been done intentionally, indicating that there are economies to be had by Increasing volume due to the scale of operation. It is generally maintained by those in the industry that efficiency in the use of labor end equipment can be effected through an increase in volume,^ Obviously this point cannot be pursued too far because the situation would vary for every dealer and for every market. It should be pointed out, however, that the feasibility of G Roland Barlett and F. T. Gothard, "Measuring the Efficiency of Milk Plant Operations," University of Illinois Agr. Eko. Sta. Bulletin AE8730. Urbana Illinois, April 1950, p, 63. Also R. G. Brassier, Jr., City Milk Distribution, Cambridge, Mass,, Harvard University Press, 1952, Chapter 11. 141 price discrimination is not dependent upon decreasing marginal cost. Programs of discriminations may be possible with inereasing marginal cost# although in all cases it would tend to reduce the differential between milk sold St the regular and discounted price. Another point probably even more important than the fact that many dealers are operating in the area of decreasing marginal cost is the fact that there are certain patterns of disorlmlnation that could cause a further drop in the marginal cost c m ’ve at the point where quantity price discrimination is initiated. So far# it has been assumed that the marginal cost cui*ve repre­ sents the added costs involved in selling additional milk under usual market conditions. That is, it involves the usual processing, selling, and administrative costs that would be found for a general expansion in the market under flat pricing.  general market-wide program of quantity price discrimination designed for everyone in the market would certainly bring about many additional costs over a flat pricing policy that would be reflected in a higher marginal cost curve. However, it seems very logical to assume that through designing a restricted market program for consumers with a favorable purchasing pattern 148 for discrimination, the oost structure for additional quantities of milk would occasion advantages that would lower the marginal cost curve. This would mean that the discriminatory program would also become'Inter-consumer”, or designed for a special group of consumers. The dis- arimination between consumers would be made upon the basis that certain patterns of purchases are more adapted to intra-consumer discrimination than others. Suppose that ce,rtala consumers in a market are offered the opportunity of purchasing additional milk at a reduced price because they have a uniform delivery purchase pattern, let these people have the privilege of purchasing an additional quart of milk per delivery at a discriminatory price determined by the marginal costs involved in placing this milk in their hands. In addition to the cost reduction attributed to the differential between fluid milk and manufacturing milk prices, other cost reductions are possible due to the economies that can be affected in processing and distributing the milk. In most markets from 40^ to 60^ of the retail price goes to the marketing £ function, under present marketing conditions. * In a study ® "Fluid Milk and Cream Report," United States Department of Agriculture. BAE. January 16, 1963, pp. 8-6. 143 conducted in the Mew York-Mew Jersey Metropolitan area from 1941-48, it was found that the consumer’s dollar was allocated as followss Producers; 5T.6 cents; receiving, processing and freights 13,4 cents; bottles: 4,1 cents; selling and delivery: 20.9 cents; and other: 4,0 cents. In most Instances it is considered that the selling and delivery expense constitute* from SO-30^ of the retail price* A study in Mew fork City in 1949 showed delivery a costs to be as high as 7 cents per quart for one plant. Many Indiana dairies reported their delivery costs to be from 3 to 6 cents per quart in 1960.9 With the general Increase in wages since 1950 it is very probable that many markets have delivery costs from 5 to 7 cent© per quart. The cost Involved in delivering a quart of milk constitutes a very Important source of savings in a quantity price discrimination program centered around ^ lei and Spencer, "An Economic Study of the Operations of Six Leading Milk Companies in the. Mew York-Mew Jersey Metropolitan Area 1941-48," Cornell University Agricultural Experiment Station.. Bulletin ..AEMi, Ithic^ Mew York, J^ , 1^49, p# 3, ® Report of the Mew York State Temporary Commission on Agr*, Cit., p. 47, 9 John W, Hicks and Q. B, Wood, Op, Cit.. p, 5. 144 delivered milk* If participation in a program is restricted to çonsimers who already have milk delivered to their home» then the marginal milk sold at a discriminatory price can be delivered with a very small Increase in the marginal cost# That there is very little additional cost in delivering an extra quart or two of milk to a customer who is already taking milk is verified in several studies. Indiana it was found that the time required to deliver six quarts to a customer is only 0*1 minute more than the time required to deliver one quart. In a study in Mew York City it was found that one company had a cost for an average customer call of 18| cents. 11 It was also found that the average number of quarts delivered per customer was E#86, resulting in a cost per quart of about 6-| cents* By allocating the costs on © customer basis the importance of volume was stressed as a means of reducing the costs on a unit basis. Many costs are Incurred in delivering milk to consumers that are practically the same regardless of the volume delivered. Some of these economies are driving between customers, collections, recording deliveries, loading 5Mâ*> p* 4. ^ Report of the Mew York state Temporary Commission on Agr., Qd. Cit.. p. 35. 145 and unloading the truck# etc* The time for the delivery trip from the truck to the door 1* praotioelly the same for e given ouetomer regerdleee of the volume delivered# within normal limite. The nature of these activities allow important économies that o&n profitably be used to widen the differential in a two-prlo® system of diserimination. It does not seem unreasonable to assume that if dealers and their route men would cooperate to the extent that they were only covering their marginal costs for the delivering and selling function©# a savings of four or more cents per quart would be possible from these activities alone in some markets. If processing end bottling costs were handled in a similar manner# at least a one or two cent par quart reduction seems possible from that source* It seems very reasonable to assume that with the present pricing structure found in m m y markets a total differential between the flat price and & discriminatory price of 10 cents per quart would be possible for certain methods of discriminatory practices* Without any empirical data ou which to base conclusions# a differential of this size, or even one smaller# seems to warrant every consideration as a means of exploiting the consumption of fluid milk on a price discriminatory basis. 146 IT this assumed reduction in cost of 5 cents per quart due to economies effected in the distribution of milk were incorporated in the marginal cost curve# it is readily apparent that the curve would fail from B to I rather than to K at quantity OF of milk in Figure 12. Suppose the cost curve take© the path indicated by TS after reflecting the change in structure of the marginal cost curve at quantity OF of milk. A new equilibrium point is reached at point % where the marginal revenue (PG) is equal to the marginal cost (TS). The new price is indicated by QV (or 15 cents per quart) and the total quantity of milk taken under the two-price plan is OQ. The additional revenue added to area OYPF because of price discrimination Is represented by FWQ* It can be seen that through the effect of the 6 cent change in the marginal cost due to the economies in distribution the additional quantity of milk sold is PQ as compared to FM when only the price differential between fluid and manufacturing milk was used as a basis of discrimination. Discrimination Recuire© Goouerative Effort Once again the point is emphasised that if the producers, dealers# routemen, etc.* cooperate to promote the sale of fluid milk through discriminatory pricing# 147 the results that might be obtained In some markets are very promising# However, If any program of discrimination Is not a joint effort on the part of ail concerned, then It Is readily seen that the possibilities of success are greatly reduced* The lack of participation on the part of some persons concerned not only reduces the quantity of milk that can be sold, but even more Important, It brings about an unfair distribution of gains that may be obtained from such a program. This can be seen In the following example. Suppose producers and dealers were willing to participate in a marginal cost program of discrimination# while the route­ men Insisted on their usual margin for all quantities of milk delivered under the program, Under such circumstances It is obvious that in reality the routemen would be subsi­ dized by the producers and dealers. For all the milk they delivered under such a program they would receive a margin that would be greatly in excess of any costs they might incur. Gush inequities would certainly bring chaos to the inauguration or operation of a discriminatory program. It should also be pointed out that secondary benefits from a discrimination program must be considered in arriving at a differential for a two-price program. If some consumers can be encouraged to increase consumption 148 Of fluid milk for six to nine months of the year through a seasonal program of diserimlnation» it is very possible that some will continue their increased consumption of milk when the program is discontinued for the year# Theoretically speaking, this would mean that these consumers do not have a reversible demand curve. Such Indirect benefits are very nebulous and hard to measure, but it seems advisable to give consideration to them in counting the long-run costs and returns that have to be considered in a quantity price discrimination program# Two Points Emphasized The analysis of an aggregated market up to this point reveals two very Important points of any quantity price discrimination program for fluid milk as a method of Increasing coneumptlon. The first one is that the spread or differential between the flat and the discriminatory price should be as great as possible. The second is that the quantity sold at the flat or higher price should not be Influenced or altered adversely by the quantity sold at the lower price. In terms of Figure IE it means that the area OYPF must remain substantially the same with or without discrimination. 149 Keeping the quantity sold #t the higher price constant Is e very difficult and real problem In most programs of latra- or inter-price dlsarimlnation# In the ease of milk, which, under present day refrigeration# is storable for two or three days it is possible to substitute the milk purchased at the lower price for milk that would have been purchased at the higher price, Such practices would not necessarily Increase the quantities of milk sold to th# consumer, but would only lower the average price paid for milk under a discriminatory program* The leek of control or method of checking the consumption of milk brings about many limitations to any program of discrimination# theo- reticelly speaking, on a seasonal basis, all milk above the usual requirements of the consumer could be sold at a discriminatory price with both direct and indirect benefits to the fluid milk industry# If it is assumed that the aggregated demand curve for fluid milk is negatively inclined, then, it is readily seen that any decrease in area OTPF would have to be made up by an increase in area PWVQ in order to keep the total revenue constant. This places rather severe limits on any program of dlaorlmlnation, since it means that a unit decrease St the high price xaust be compensated for by much greater 150 thaa a unit increase at the lower price in order to keep total revenue constant. The restriction becomes even more severe if one considers the net revenue per unit is much greater at the higher price. There Is however, some limited degree of flexibility in adjusting the programs to certain types of consumption patterns other than those with exact periodic uniformity. It is possible that the assumption that area OTPF has to remain unchanged for any program of discrimination could be relaxed. It seems practical to conclude that programs could be set up around certain consumption patterns that would allow some small diminution in the area ÔYPF that might be, at least, partly offset by an Increase in area FWQ. Even if there were no partially offsetting compen­ sations, it is still very probable that some loss in area OTPF is tolerable, when it is realized that it is a sacrifice that Is made to realize the ends represented by area FWVQ. The limitations and restrictions that must be placed on consumers that are offered the opportunity of participating in the program are very great. These disadvantages would have to be weighed in the light of existing consumption patterns and market conditions to determine the advisability of any program of quantity price discrimination. 151 GummtM M. . Fir^ the analysis based upon the theory of the firm under mcnopolistlG conditions has consisted of only rough approximations of the situations that would be encountered in a discriminatory pricing program* The results obtained, however, confirm the possibility of using discriminatory pricing as a means of Increasing fluid milk consumption in markets where the differential between the two prices can be considerable and where consumer purchase patterns can be subjected to the limitations and control required for discriminatory practices* The Importance of lowering the marginal cost as a means of increasing the price differential, and thus favorably Influencing the quantities of milk sold through discrimination has been emphasized by the analysis. It is evident that the big hurdle to price discrimination Is to find selling techniques for consumers that will encourage additional consumption at the lower price without affecting unfavorably the quantities purchased at the higher price* GHAPTm VII LIMITATIONS AMD WEAKNEGGES §Qm@_ _A@ on# of atatl® BaonomlofS Every static analysis is predicated upon some assumptions. These assumptions, which are made either explicitly or implicitly, form the foundation upon which a framework Is built to determine or describe the relationship or actions of certain variables. The analysis presented la the four preceding chapters Is subject to all the weaknesses of static analysis. Primarily, the tools of micro-static economics have been used In developing the analysis. It Is now necessary to consider some of the assumptions that are involved in the light of more realistic dynamic situations to determine some of the limitations and restrictions that might influence or modify the results of the analysis. Some of the static micro-economic assumptions that are particularly relevant for this study are the following; 1. Perfect knowledge is assumed for both production and consumption. B. Production functions of the economy are fixed by a given quantity of productive factors, state of the arts, etc. 153 3. Tastes, habits, preferences, customs, etc*, of the consumers are fixed in a well-ordered, nonooïiflioting manner. 4. Consumers are rational end attempt to maximise their satisfaction from the resource© at their disposal, 5. Institutional factors are such that producing and consuming individuals and groups make their choice© free of force or coercion. An old truism asserts "Time changes everything". It Is obvious that the assumptions of static economics violates the realistic problems presented because of time. Economic relationships Involving time often step over the boundaries of static assumptions and invalidate consistent and logical static theory. Partial Eouilibriüm Analysis The Indifference curve technique as expounded by J. a. Micks, and others, was used as a basis for presenting the case of price discrimination. This technique is a type of partial-equilibrium analysis. It is obvious that a demand schedule for a commodity like milk, which Is drawn up on the assumption that the prices of all other commodities remains the same while the price of milk experiences considerable variation, enters the realm of absurdity, other prices do not and cannot remain the same while changes in the price of fluid milk occur at 154 the same time. A general equilibrium approach assumes that all prices are mutually interdependent and the possibility of depicting the demand or supply schedule for any single commodity is very unrealistic# The price of milk is only a vary small part of the whole economic system that must be considered in a dynamic setting. Walras* Pareto and others have given an insight into some of the problems involved in a general equilibrium approach, but unfortunately* their techniques have limited use in solving practical problems. As with most economic studies the analysis must rest subject to the limitations of any partial equilibrium presentation* Indifference Curve Analysis does not Handle the Problem of Complementarity Hicks has made the following observation; The indifference diagram, measuring its two 'commodities’ along its two axes Is only useful when the consumer can be thought of as spending his income upon two ’commodities' and two ’commodities’ only; this usually means, in practice, that it must be applied to the case in which we are interested in problems of the demand for one physical commodity, and measure along the other axis all other commodities lumped together (Marshall’s money). For these problems Marsahll's problems - the indifference diagram is very Instructive* and enables us to put a keener edge on the analysis than is possible by Marshall’s methods. But the problem of related goods cannot be treated on a two-dimensional indifference diagram. It needs three dimensions to represent the two related goods and money.I ^ Hicks, Oo. Cit.. p. 45. 156 la the eaalyslB presented for fluid milk ao allowaaae was mad® for commodities that might be o omplemeatary. When a consumer is spending his income on more than two goods other relationships ere possible besides substitution. It is possible to assume# as the indifféréace curve tecimiqu® does, that all other commodities are substitutes for milk. However, this is not realistic. It is much more reasonable to assume that there are some commodities tliat are comple­ mentary with milk, although the number may be very limited. Hick® points out that any particular commodity will have at least a small group of complementary commodities, although the most probable relation with any other good taken at random is apt to be one of substitutability. It is very possible that the element of complementarity of commodities with fluid milk may be somewhat more restricted than for m m y items. Fluid milk used strictly as a beverage may involve very little complementarity. However, when one stops to think of milk used in cooking# for cereals, etc., the element of complementarity immediately becomes very evident. The degree and the effect of complementarity on the analysis presented is difficult to reconcile. However, it must be pointed out as one of the weaknesses of the analysis. It is possible that a fall in the price of milk has little or no influence on many commodity prices. U?.i.4»* p. 47. 156 Hick® points out the oases where the fall In the price of X has no influence on the demand for X. He states ! ...this may happen, it is clear, either if both the Income effect and the substitution effect on the demand for X is negligible (leas than the minimum sensible); or if they are not negligible taken separately, but they go in opposite directions, their difference is negligible.^ Hicks maintains that many of the commodities con­ sidered by economists to be independent of a particular commodity X com© under the first heading,-the price of X does not affect them in any way. He feels, however, that a fair number of commodities come under the second heading since it is not likely that all the substitution in favor of commodities comes about at the expense of close substitutes. He is inclined to believe that mild substitutability is present which is offset by income affects.^ If Hicks' contentions are true, It may be possible that many of the refinements that could be incorporated into a partial equilibrium analysis would not change the basic results. To what degree these circumstances apply in the analysis of milk is a matter of speculation. any analytical work there is a limit to the degree of ^ Ibid.. p. 49. ^ Ibid.. p. 49. In 157 accuracy that can be achieved. Bine© the analysis presented is only meant to be rough approximations of possible situ­ ations, it is not likely that the basic premises of this study would be greatly altered by some of these refinements* lM-_MtuapilQ.n. of MplonAl Behavior An implicit assumption of the Indifference curve technique is that people are able to make consistent choices between a rather comprehensive collection of goods. Morris points out that economics’ sister sciences have "gradually been developing a concept of man which reveals him #s 'irrational* over wide areas of conduct, habit ridden, and culture-dominated. The very concept of 'rational' behavior « so implicit in all the contemporary fr schools of economic thought - is called into question." She points out that some selections between various goods are made rather consistently. She Indicates that a selection between four hats and four pairs of shoes and three hats and six pairs of shoes may be consistent. She continues by stating "I doubt very much, however, one's ability to form an opinion as to whether the foregoing combinations are equal to, less than, or more desirable Ruby T. Norris, The Theory of Consumer's Demand, Tale University Press, New Haven, Conn., 1962, p. 9. 158 than (ten pair of ahoee and no hats) oz* (twelve hats and no shoes )» or no hat#*" We are simply not accustomed to have ao shoes 6 Some individuals very closely associated with marketing problems feel that consumer behavior and conduct Implied by economic theory is unrealistic and often misleading* This is indicated in the following statements The science of marketing must progress through constructive interaction between fact finding and deductive analysis. Eeonomio theory in its purest form has not been contaminated by contact with fact finding. Marketing necessarily concerns itself with the organising effort that makes possible the orderly flow of goods. Economies assumes a# already given the results laboriously achieved through market organization. Marketing is obliged on the basis of its own empirical findings to regard much of consumer demand in the light of acquired behavior. Mo theory can illuminate the facts about,demand unless it has come abreast of the modern psychology of learning. Reference could be made to many individuals end writings that challenge the usefulness of economic theory g in explaining or predicting consumer behavior. It is ® Ibid.. p. 47. ^ Wroe Alderson, "Survival end Adjustment in Organized Behavior Systems," Theory in Marketing. edited by Cox and Alderson, Chicago, Richard D. Irwin Company, Inc., 1950, p. 65. ^ Ibid., p. 41. For an alternative approach see article ” Ey Joseph Clawson, "lewin's Vector Psychology and Marketing, " Th8ory_Qf_Mark® 159 beyond th© scope or the purpose of this study to enter into this issue. Most people recognize that economic theory can make some contribution even if it is only a partial solution. Bather than discard economic theory completely because it fails to meet fully the needs of a particular situation, it seems more advisable to employ its virtues and recognize their limitations and restrictions. The indifference curve technique, at best, is highly conjectural in areas that are remote from the experiences of the consumer. Henry Schultz, an adherent of the in­ difference technique, has made this observation: Most persons simply do not know how their consumption Of a given commodity would be affected if prices were to move much above or below their accustomed rang©, and even within the accustomed range there may be a great deal of uncertainty. They must experience a given set of price relations in Its proper insti­ tutional setting in order to make up their minds as to the quantities they will purchase.^ It is a stretch of the imagination to visualize the behavior of individuals postulated by indifference curves even within areas closely adjacent to positions that might be experienced in reality* Mjuetmenta of a more extreme nature involve many new and unforeseen problems. ^ Henry Schultz, The Measurement of Demand» University of Chicago, Chicago/luSo, P* lU- lêO îhe market for fluid milk Is generally oonsidered to be extremely stable* Price variations of more than one or two cents per quart are usually not experienced. The use of fluid milk is ordinarily associated with deep* rooted habits and customs which an indifference analysis is not apt to emphasise* The nature of the consumer's adjustment to price changes is in many ways similar to those Involved on the supply side* It is standard pro­ cedure to consider the adjustments associated with the supply of any commodity in terms of a given time period. For example# Marshallian analysis has distinguished three rather distinct periods which are helpful in understanding adjustments requiring various periods of time*^® market period stocks are regarded as constant. In the In the short run production is permitted from the fixed plant and equipment. The long run period is characterised by entry and exit of marginal firms and by adjustment of the fixed factors consistent with the state of the arts. Norris maintains that "Neither demand nor supply should be treated in an undifferentiated way with respect to time. A short run theory of demand needs to be developed Marshall, On, Git.. p. 411-416* 161 in quite different term* from the conventional ones* for in the short run the usual marginal utility approach, the indifference curve, or any variant of either is almost wholly irrelevant* It must be recognised that most consumers are creatures of habit to some extent with respect to the things they buy. Through product differentiation, selling costs, advertising, etc#, many people from force of habit limit their purchases to certain brands of any commodity. In the case of supply it takes time to make adjustments in plant capacity and layout of a permanent nature, like­ wise in the case of demand old habits are not broken and new ones adopted without some time-oonauming adjustments. Norris has set up the following classifications for demand: If tastes and Incomes be considered the two major variables behind consumer demand, then the 'short m a * for purposes of an analysis of demand can be defined: A period of time so short that no changes in income occur and no changes in established consumption rates occur. The ‘long run* would then be a period during which habits are formed and broken, and income may increase or decrease. It hardly seems worth while to try to associate demand with exact time periods in the case of demand Ibid.. p. 97. Ibid.■ p. 97. 160 for fluid milk, Experlenoe In some markets has been that after a price adjustment occurs, especially upward, some people Immediately alter the quantity of milk purchased. After the price has prevailed for a considerable period of time it is felt that many of these same people revert to about the same purchase patterns that prevailed before the price change. Other studies show that consumer adjust­ ment to price changes is gradual and follows approximately the pattern specified by Norris. In m y instance the analysis presented under static assumptions has not taken time period adjustments into consideration* There can be no question that these adjustments are real and capable of greatly modifying the results of the analysis, Un­ fortunately there seems to be no consistent theory that can be used to predict accurately these time period demand adjustments for fluid milk. Price Bla&tlcity of pemend Through Tim# Most economists maintain that instantaneous demand curves are less elastic than those Involving a considerable period of time. Stigler makes the following observation on this particular point ; It is generally accepted that the elasticity of demand for a commodity increases with time, e.g., a 1 per cent decrease in price may lead to only one-half of 1 per cent increase in the quantity urehased Immediately after the price cut# but ater the quantity may Increase by 8 or 5 per cent. It is assumed that consumers* tastes do not changeî if the rule of Increasing elasticity through time were based on changes of tastes, it would be merely a dubious historical generalisation.15 Btigler lists three reasons for this situation. The first is technological in which he maintains the consumer does not have the ability to adjust consumption patterns immediately because of price considerations. Even if the product whose price has fallen does not involve any special problems, often complementary products that are used with the product whose price has fallen require that the consumer makeplans that take time to execute. The second factoris imperfect knowledge in which some 4 consumers may not know about such things as changes in price which prevents them from making the desired adjust­ ments immediately. This factor is considered to have little effect on quantity price discrimination for milk, since it is assumed consumers will be Informed about pricing policies involving a two-price system and will thus be encouraged to alter their purchase pattern accordingly. George Gtiglor, The Theory of Price. lew York, The MacMillan Co., 1947, p. 93. a m - , p. 94. 164 The third factor, according to Stigler, Is habit. This he considers of general applicability and Importance. He state®Î A price cut requires some time to make its full Impact on consumers. Budget® must be rearranged# and the relative merits of other commodities must be reappraised. The inertia which prevents instantaneous readjustment of consumer behavior contain® some rational elements. The consumer, for example# may deem the effort to readjust hi® purchases excessive in light of the probable reward# and the readjustment may come only after a considerable number of price changes make it __ worthwhile to reappraise his consumption pattern. Stigler reasons that delays on the part of the consumer can be explained without considering any alteration in the tastes and preferences of the consumer. Time-consuming adjustments is all that is required to explain the difference In the price elasticity of demand between the Instantaneous and the long run demand curve. Insofar as this reasoning is correct, It does not seriously damage the analysis based on static assumptions. It seems fairly safe to assume that most consumers could adjust their household so that Increasing or decreasing the quantities of milk that they consumed would not Involve greatly extended periods of time. This would mean that program of quantity price discrimination would have 16 Ibid.. p. 94. 165 to Include a period of time that would allow the consumers to make these time-consuming adjustments. Adjustments Because of Change in Taste Xn the analysis under static assumptions it was assumed tastes and preferences remained unchanged and were independent of prices. Stiglor has indicated how habits can alter the analysis without assuming tastes have changed* In the case of fluid milk it seems un­ realistic even to assume that tastes are constant over a considerable period of time# It seems consistent to assume that fluid milk would satisfy different psychological desires and preferences during the hot summer months than during the cold days of winter. Certainly tastes and preferences are subject to change just as habits are subject to change. Whether it is possible to separate the two seems questionable. The indifference analysis presented in this study assumed that the indifference curves were reconstituted daily at precisely the same position. This assumption definitely specifies that tastes and preferences ere fixed. Changes in taste involve a shift in the entire demand curve, whereas Stigler’s habits would seem to involve time periods required for moving from one point to another 166 on the same demand curve. In the case of milk# if there is an increased desire on the part of the consumer for it, it would be reflected in changes in the slope or a siiift of the indifference owves, and thus the demand curve# to the right. This shift would indicate that at any particular price the consumer would be willing to take a greater quantity of milk# or conversely# for any given quantity of milk the consumer would be willing to pay a higher unit price. Mlghell and Allen maintain that it is useful to consider the effect of time on demand tooth in terms of what happens to the demand schedule and movements involved along the same schedule# They also indicate the weak­ nesses of considering price responses as being limited to Instantaneous demand curves which neglects Important adjustment of many variables. In the case of milk they make the following observation; A price decline may stimulate some Increase in consumption immediately, but a further increase in consumption will involve the use of milk in new ways such as in cooked dishes not previously eaten# in new types of beverages# or even as a beverage toy members of the household who had not previously used it. The greater part of such changes in consuming habits may come about only I® R. 1. Mighell and H. H. Allen, "Demand Schedules'Normal* and ‘Instantaneous*," Journal of Farm Economies. Vol, 41, (August# 19391, p. 555. 167 gradually over e considérable period, ... At this Juncture the objection may be raised that this type of change in consumption is generally recognised as a Shift in demand. In a sense it is a shift, but it is brought about in part at least by the price change or perhaps more correctly stated by the existence of the new price situation for a suf­ ficient time. Or, to employ more technical language, the utility function or the indifference system of the individual Is partly dependent upon previously existing price relationships and may be altered in the course of time as a result of changing price relationships. The point to be emphasized here is that by treating all such changes in consuming habits as shifts in demand we fall to recognize or draw false conclusions concerning the effects of price changes as such.*** These possibilities have not been considered in the analysis presented so far in this study, llighell and Allen point out that long time demand curves bring about a more elastic demand curve especially for lower prices. This is true because the period of time is such that practically all adjustment can be made because of price variation. They also point out that "changes in consumers * habits are not necessarily reversible, end consequently long time demand curves may best be thought of as ir­ reversible curves applying to a particular time, each point representing a resultant of a different price level during the appropriate preceding period," fbid%, p. 568. Ibid., p, 663. IS 16S It has already been Indicated that the analysis is not seriously damaged by time-oonsumlng adjustments '.'hen it is assumed that tastes and preferences are fixed. In the event that there is a shift in demand because of Changes in tastes and preferences Mighell and Allen indicate that a decrease in price will bring about a more elastic long run demand curve. If this contention is true, then these adjustments, through tins, would help the cause of price discrimination. It may mean that initial responses to any discriminatory plan would be slow and discouraging but would improve through time as people adjusted their consumption patterns. Seasonal quantity price discrimi­ nation may have the disadvantage that the time period may not be long enough to bring about the full long run adjustments, 'ilhen one considers the possible uses a household can make of additional milk# however# It seems many adjustments would be made over comparatively short periods of time. In any event the importance of extending the period of discrimination is emphasised* lengthening the period of discrimination not only allows more adjust­ ments for the period of discrimination, but if Mighell and Allen are right, it would mean that some advantages may result when price discrimination was discontinued because of the irreversible nature of the long run demand curve. X69 la Absent Borris daims that price change® should be considered in light of the importance the consumer places on the adjustments that might be involved. She maintains that there are large areas in which careful weighing between expenditures Is absent. These expenditures involve commitments of a legal or moral nature that might have been made in the past but which involve present payments. Such thing® as installment purchases, debt repayment# insurance provisions, children's tuition, etc., are of this nature. She claims that: In addition to commitments, there is another Important class of habitually consumed good© with respect to which no weighing process or utility analysis can be applied in any time period, short or long. These we have called petty goods. Each individual has a margin below which he does not think it worth while to weigh expenditures.&0 It is possible that some people consider the purchase of fluid milk in such a category, Some people may consider the value of fluid milk in the diet so Important that it almost becomes a moral commitment to provide the family with a given amount of milk with very little consideration for the expenditures involved. These, of course, involve people whose price elasticity of demand for fluid milk Norris, On. Cit., p. 99. SUM-. p. 120. 170 1® perfectly Inelastic• ■Within the price ranges usually found la the market for fluid milk it is very possible that this situation Is descriptive of a considerable uumber of consumers, The analysis presented, so far, has ignored this type of fluid milk consumer* It is also possible for many people to consider the purchase of fluid milk as a "petty good" in which the consumer does not consider careful weighing of the expendi­ ture involved as worth while. Part of the milk purchases for some consumers may come under this category. It is very possible that a consumer might carefully weigh regular purchases of milk from the milkman and adjust purchases accordingly,, and at the same time supplement this milk with purchases from the store on a "petty good" basis. The general analysis of this study does not provide for these contingencies. It is possible that they are important enough to alter the results of the analysis seriously, however, it seems reasonable to assume that there are many people who consider and weigh very care­ fully the factors of price and utility that might be associated with the purchase of fluid milk. would seem to hold for these people at least. The analysis 171 ..of...Indivisibility Indifference curve analysis may «neglect the problem of indivisible units. The smooth, continuous, indifference curve would only apply in the case of finely divisible commodities# Some of the problems of indivisibility in fluid milk have already been mentioned. However, this point■should be considered a little more in detail# In a study reported by Patsig and Hsdary it was found that there may not have been a continuous, smooth, demand curve which is implied by indifference analysis. They make the following observation: The breaking point between families purchasing and those not purchasing milk regularly could not be determined from the data at hand. However, there are grounds for believing that this 'breaîcing point* could be found around the $1000 income level. As the incomes of the families not regularly consuming milk rises to this level regular milk consumption is presumed to ensue* Thus, it is only at the ‘demand excitation* level of earnings that the inccme-demend cwve for fluid milk is relatively elastic.&1 They maintained that changes in the price of fluid milk of one or two cents per quart which ordinai'lly occur in fluid milk markets only affects the marginal consumer at the demand "excitation level", Since in any market only E# E, Patsig and G* Hadary, "Eelationship of Income to Milk Consumption," Journal of Farm Economics. Vol. 27, 1946. ITS a relatively azmll proportion of the consumers at a given time can. toe considered "marginal", the usual changes in retail price which occurs in most city markets, is in­ effective in bringing about changes in milk consumption in the short run. It has already been shown that part of the explanation of the failure of consumers to make adjustments to small fluctuations in price may toe due to the indivisibility of a quart bottle of fluid milk. Another reason would seem to lie in the price and nature of the substitute Increased quantities of milk might replace. For example, many people might consider canned evaporated milk as a substitute for fluid milk. Let it toe assumed that fluid milk is 23 cents per quart and canned milk is 15 cants per can, which is roughly equivalent to a quart of fluid milk. If this were true, then for some purposes* at least, it would seem that the price of fluid milk would have to experience a considerable reduction in price before the switch would toe mad# from canned milk to fluid milk, The substitutes for fluid milk are not in indivisible units or arranged in a hierarchy according to price that permits smooth and continuous transition from one substitute to another. During the summer months if orange-ade is considered a good substitute for milk and is selling at 15 cents per xn quart. It seems logical that many people would be encouraged to shift to milk if the price were on a comparable basis# Although the indifference curve analysis shows these substitutions as smooth and gradual processes, it is obvious that they only indicate the direction of shift and not the degree. Such concepts as "shifts in lewia's v e c t o r s , "demand excitation l e v e l , r e a c t i o n s B4r threshold, ' etc#, may be consistent with indifference curve analysis within the limitations due to indivisibility, relative prices, etc. Once again these limitations emphasize the necessity of a wide differential between a two price discriminatory program to overcome some of these restrictions that are not made apparent from the implications that may be drawn from smooth indifference curves. Conclusions In this chapter the limitations and weaknesses of an analysis based on static assumptions have been considered, Clawson, On# vit», p. 63. Patalg and Hadary, On.#. Clt, Warren Bilkey, "Vector Hypothesis of Consumer Behavior, Journal of Marketing. Vol. 16, 1951, pp. 137-151. 174 It is readily seen that in some conditions these re­ strictions can toe severe and capable of greatly modifying the results of static analysis. Under static assumptions a logical and consistent case can toe presented for quantity price discrimination as a means of increasing milk consumption. The relaxation of some of these static assumptions and the introduction of dynamic cansideration® leaves some areas of suspicion and uncertainty about the success of any discriminatory program. Hone of the limitations presented, however, seem to justify abandon­ ing attempts to initiate programs in markets where the differential in a two-price system can be substantial and where satisfactory methods of intra-consumer dis­ crimination can toe developed. Where an economic incentive is present, it does not seem unreasonable to assume that the dynamic nature of purchase patterns for fluid milk is influenced toy some static assumptions. On purely theoretical grounds, notwithstanding the restrictions presented in this chapter, it seems that intra-consumer quentity price discrimination would still toe a powerful sales technique in some markets. o m P T m VIII SOME ASPECTS OF OPERATIONAL PLANS OP PRICE DIGCRIMINATION 00# Price All plane of price discrimination, whether they toe inter- or intra-coasumer, come into being because the seller is able to exceiise some monopoly control. With the advent of advertising, product differentiation and other sales techniques at the disposal of sellers, dis­ criminatory practices in many Instances have increased as a part of the market structure. The theory of perfect competition maintains that the forces operating in the market will tend to bring about the one unique price that will adjust buyers and sellers to the point that demand equals supply. The theory and the practice of one price for all sellers and buyers of a homogeneous product has been more or lees a traditional ideal of the American economy. However, some of the most competitive industries are challenging this time-honored economic axiom. Con­ sidering the aoeomplishments that have been forthcoming from the abandonment of a policy of one price and the inauguration of various types of price discrimination in some fields, it cannot be argued that the results have all been undesirable. 176 to forsake the motion of one price for the same product for all eoasumers in some cases may herald the return of more aggressive competition that offers great improvement to the economy, A case in point would seera to be the experience found in recent years in the home appliance, television end radio Industries. In 1958 these items were doing am 8.6 billion dollar retail business.^ It is now reported that television sets outnumber bath tubs in Chicago. They outnumber home telephone sets in Chicago* Lee Angeles# Philadelphia, Bt, Louis, Cleveland and Boston.® the great advancement has practically all occurred within the past six or seven years. à comment found in Fortune magazine very appropriately describes the nature of the market existing for these products. "Anybody who buys appliances at retail list is either illiterate, has a bad credit rating, or is plain stupid*"^ It is common knowledge in the industry that price discrimination in various forms has characterized the general sales policy thathas greatly contributed to the high volume sales of these products. ^ "Who Pays List Price?," Fortune Mmazin^. June 1952, p. 104, ^ "Business and Finance Section, Time Magazine. March 16, 1353. 3 rtîiuo Pays List Price?," Op# Git.. p. 105. X77 ît la possible that discriminatory practices are destined to play a more Important role in the sale of an Increasing variety of products. This is indicated by the following statementj Within the past year some formidable questions have suddenly appeared about the way in which goods are priced for the American market. The trend with the overtones is price cutting below the manufacturer*s suggested retail price, which flourishes everywhere In the midst of unprecedented prosperity, Here are the kinds of questions it raises* Is list price becoming a pious fiction rather than an economic fact in American retailing? Are retailers and consumers abandoning the century old 'one price policy* that built the great U*8, retail enterprises, — all customers in a given store paying the same price for an article— In favor of a bargaining and haggling approach? How much of a spread can be justified between the manufacturer's price and the retailer's selling prioe?4 Pricing experience in the electrical appliance field is on interesting and Important development not only because the consumers are becoming accustomed to disregard the traditional "one price policy", but also because it represents a trend on the part of the seller to price goods on a marginal cost basis. The idea that a given margin must be realized on ©very unit no matter how or to whom it is sold, or else the sale should not be made, is proving to be a poor pricing policy ^ Ibid,, p. 106* 170 in some fields of retailing, a hardware dealer in a small Texas town summed up his experience as follows : If a man comes into my store and wants to buy a Frigidaire, I'll get the deal because 1*11 cut the price# It muddies up the water for the rest of the dealers, but I don't car®, because I'm in hardware ; and if I can make twenty bucks on the deal that just means twenty bucks less hardware I've got to sell.w Experience in the appliance, radio end television fields shows that consumers accept the fact that different pricing policies can prevail for different people. If this experience could be extended to the sale of fluid milk under programs of price discrimination, it would allow much greater latitude in designing programs that would fit the needs and purchasing patterns of individual consumera# The fact that all families do not have the same or similar purchasing patterns for fluid milk precludes the possibility of designing a simple marketwide discriminatory program. To some extent it would seem that discriminatory programs would have to be formulated for groups of people exhibiting similar characteristies in their purchases of milk. That consumers may accept discriminatory practices which are tailor-made for a variety of inter-consumer groups is strengthened ^ Ibid., p. 106. 179 the activities described above In the appliance field as well as those found in other areas of retail merchandising, of .Intra-Qonsumer Discriminât ion It has already been stressed that monopoly elements ere always Involved in discriminatory pricing# However, the presence of monopolistic powers in and of themselves are not sufficient to assure success in discriminatory practices. Discrimination is possible only under certain rigid market conditions. More specifically, quantity price discrimination is feasible because of an increase in marginal revenue and/or a fall in the marginal cost of the units sold under discriminatory pricing. In some instances where quantity discrimination is part of a sales promotion campaign, future expectations as related to favorable changes in these two components are involved, however* practically all plans of discrimination can be roughly analysed under the changes brought about to marginal revenue and marginal cost because of price discriminât ica. An interesting example of inter- and intra-consumer discrimination is the promotional campaign conducted by 180 publishers of magazine. ^ Before the Christmas season of 1962 special Christmas rate® were advertised. Oil a purely intrm-consumer basis individuals were en­ couraged to subscribe to the magazine as gifts for relatives and friends. For any one participating in this offer, the first gift subscription was listed at the usual subscription rate of $6.00 per year. After a person had placed an order for one gift at the regular price of #6.00, he was entitled to additional subscriptions for gifts at 14.50 per yearly subscription» Presumably after completing the initial subscription at the regular price# one could purchase unlimited gift copies at the reduced price of #4.50# although the prepared form aoooEmodated only three gift subscriptions. In a comprehensive program of inter-consumer dis­ crimination# the magazine was offered to students at "special student rates". On a stamped aelf-addressed card the company offered students the opportunity to subscribe to the magazine at the rate of $3,00 per year Tim®, a Weekly News Magazine, Time and Life Building, 9 Rockefeller Plaza# New York SO# N. Y. Data for this sales technique were obtained from folders found in the magazine, cards handed to students as well as promotional material received in the mail. lai I m t e W of the regular yearly subscription rate of $6,00. A® a sale# lever it was pointed, out on the card that the news stand price was so cents per copy which meant the student could make savings up to 70 percent by taking advantage of the student rate. After subscribing at the student rate of 15.00 per year* it was found that a renewal courtesy rate was #4.76 per year. An alternative offer was also available for 5 years for 110.00. However, special student rate cards specifically stated that a student could renew his present subscription at the student rate of $5.00 per year presumably without regard to the nature or rate that applied to the expired sub­ scription. The above illustrations of discriminatory pricing are presented to indicate the complex nature of the problem involved In using discriminatory practices in selling magazines. Starting with the regular rates, offers are made in sequence so that each offer becomes a little more attractive than previous offers until the potential customer has subscribed to the magazine, or the company reaches the position that lower offers are not profitable. It is readily seen that prioo discrimination offers possibilities of profit even though it presents many problems of a promotional and administrative nature. Expanding sales IQB fey offering price Incentives to those who normally would not fee assumed to eufescrifeo to the imgazlne increases the marginal revenue from subscriptions. The possibility that many of the individuals who subscribed at reduced rates can fee encouraged to subscribe at a higher rate, or the regular rate, increases the expected future marginal revenue. The importance of circulation in quoting advertising rates would seem to favor price discrimination as a means of Increasing the mmfeer of subscribers* Although the promotional and sales costs involved in these Intra- and Inter-eonsumer programs may more than offset economies due to volume in printing the magazine, the favorable effect that discrimination might accomplish in. Increasing the marginal revenue would seem to fee sufficient to explain discriminatory practices in promoting the sale of the magazine, A recent trade allowance sale on tires by Sears can fee cited as another example of intra-consumer price discrimination,^ In this particular sale a trade al­ lowance of 10 percent on the regular retail price for one tire was authorized, if a customer bought two tires. T Geers advertisement in The State Journal (daily newspaper for Lansing, Michigan), April S, 1953. 183 If three tires were purebased, a EO percent allowance was given for the third tire. If a customer bought four tires the allowance was 30 percent on the fourth tire. At first sight this particular sale would seem to involve nothing more than quantity discounts which could fee explained because of economies brought about fey selling one or more tires to the same person. Closer examination, however, reveals that favorable results ai*e forthcoming from the marginal revenue side of the picture as well as from marginal cost. In the first place if a person purchased only one tire at a time, he is always presented with the opportunity of feeing able to buy part of his replacement tires from a competitor. Any purchase from a competitor, even if it fee only one out of four tires represents a loss of marginal revamie from that particular customer. Only under very unusual circumstances does it seem possible for a given company to sell as many tires one at a time as it would sell where they were sold in multiple units consisting of two or more tires. As will fee shown later this particular point seems important in the sale of fluid milk. Another factor that favorably influences marginal revenue is the receipts to the company for the tires turned in under the trade allowances. Good casings have 184 value for recapping purposes as well as for being remounted as used tires* The better the used casing# the greater the price It Is able to eomi&nd. the same wear on an automobile. Bo two tires experience If one tire is traded, reason would dictate that it be the poorest tire on the automobile# If two tires are traded, they will be the two poorest tires, although one may be considerably better than the other, ihea three or four tires are traded by a motorist at one time# In all probability one or two of the used casings will be able to command higher prices in alternative uses which become part of the marginal revenue from the transaction for the company. Thus, in addition to the increased revenue from sales as a multiple unit offer that would not be forthcoming on a single unit basis, the marginal revenue is also favorably influenced through intra-consumer quantity price discrimination because of the higher resale value from used tires sold under a multiple sale* Actual cases of various methods of price discrimination are too common to justify any further elaboration on tkils type of sales technique. The two actual cases of dis­ crimination presented above are examples of more complex sales techniques involving intra-consumer discrimination. They illustrate very well the influence of discrimination 185 &n marginal eo®t and/or marginal ravema* In addition to indicating that the oonaumar has a downward sloping dis­ criminât ion demand curve for thasa pai'ticnlar items and can toe influenced to make purchases accordingly, these examples also emphasise the willingness of the companies involved to adjust their selling policies to a marginal eost^marginal revenue basis rather than to maintain a constant price for all units sold and to attempt to make a fixed average margin on each unit. The persistent and increasing use of price discrimination as a sales technique not only indicates that companies engaging in this type of sales promotion find it profitable, tout also suggests that it may be desirable and profitable to expand these activities to other areas, even to fluid milk# as a means of increasing sales. Pflce Discrimination for Delivered Milk The critical and focal point which will determine the success of any program of quantity price discrimination for fluid milk rests on the ability to formulate operational plans of discrimination, although some very practical problems are involved between producers, dealers, delivery­ men* etc., these particular matters are secondary to formulating sales teclmiques that will accomplish the 186 purpose of discriminatory programs. If satisfactory plans can be presented to accomplish the objectives of price discrimination as revealed by previous analysis, a strong incentive would exist for overcoming any secondary hurdles that might be present* One of the first limitations that is placed on ai^ discriminatory program is that the buyer mist not be able to resell the low price product so that it will interfere with sales in the market at the regular, or higher price. Inter-consumer programs Involve some type of restriction which prevents resale to other individuals or groupe* Intra-consumer discrimination not only Involves restrictions to prevent resale to other individuals end groups, tout ©Iso the added limitation that individual consumers are prevented from substituting the product .purchased at the lower price for that which would have been purchased at a higher price, if the opportunity of a discount on soma units had not been present. The wider the differential in a two-price system of discrimination, the more incentive consumers will have to participate in resale and substitution activities* %here milk is delivered to the home of the consumer some checks can be initiated to prevent or discourage resale to other consumers. Dealer-imposed restrictions 187 Oîi the quantity of milk that consumers can purchase at the lower price would seem to be all that is required to prevent most, if not all, this leakage. Delivered milk is usually delivered every other day* limiting each family to one quart at the discounted price would certainly discourage most people from attempting to resell to a neighbor, The opportunity for profit from the sale of one quart of milk would seem to be not worth the trouble* If it be assumed that larger families purchase more milk per delivery, then it would seem that on a per capita basis these families could use more milk purchased at the discounted price without being tempted to resell it* Since the increased sale of fluid milk is the major objective of discriminatory programs* families should be urged to purchase as much milk at the discounted price as they desire, provided that the milk is not used in such a manner as to Interfere unfavorably with quantities purchased at the regular price* On this basis it would seem that large families could be given the opportunity of purchasing additional milk at the lower price. This could be handled very easily by establishing breaking points predicated upon the amount of milk that was delivered to the family. 188 example, families purchasing three quarts, or less, of milk every other day, could be restricted to one additional quart at the discounted price* Families purchasing four or more quarts could be allowed to purchase two additional quarts per delivery at the lower price* This arrangement, provided that resale problems were not involved, should not only increase the quantity of milk sold, but should make a discriminatory program more inviting to families consuming large quantities of fluid milk, which might have a tendency to consider their purchases on an average rather than a marginal cost basis. The problem of leakage or resale which might interfere with milk sold at the higher price of a two-price system of discrimination would appear to be a manageable problem for delivered milk as such. However, a problem is presented where families have a tendency to purchase milk from the store to supplement delivered purchases* In some markets this particular type of purchasing pattern may be very common. In markets where cash-and-carry outlets which sell fluid milk at a reduced price are available, supplementing delivered purchases with milk from these sources may be an insurmountable obstacle to any program of discriminatory pricing. In these particular markets 189 if people limited delivered purchases to a minlKum for purposes of convenience and tended to make substantial purchases at the cash-end-carry outlet in order to realize greater overall savings on fluid milk purchases, the over­ lapping of the consumeras sources of supply would seriously hinder general market operations. However, if it be assumed that reduced prices are available at cash-andcarry stores because of the ability to reduce marketing margins, then discriminatory programs involving; delivered milk also involves reductions in margins that might bring about some competitive features that would be desirable for some markets, Gome overlapping of consumer's sources of supply would appear to exist in all markets. The possibility of some leakage or substitution of cheaper milk for that which would have been purchased at a higher price is always possible in these conditions. If the leakage is great enough it would render impossible discriminatory programs involving fluid milk. In Chapter VI it has been pointed out that some leakages are possible which would not disrupt general market-wide programs of discrimination. Most, if not all, programs of Intra-consumer discrimi­ nation Involve some leakages which for practical reasons 190 are unavoidable. In the case of fluid milk, as in the case of other coimiodlties, the answer to the problem lies in selecting markets and/or techniques where this ob­ jectionable feature can be reduced to proportions that will not Interfere with the general operation of the program. In many fluid milk markets the trend is foi* consumers to purchase a greater proportion of their milk from stores and cash-and-carry sources* However, in some markets practically all the milk is delivered to the home of the consumer. This fact is especially true in smaller cities where retail store outlets are limited and a price differ­ ential between store and delivered milk does not exist to encourage sales tlurough stores# Even in a city like Lansing* Michigan# it was found that 101 consumer panel families purchased 74 percent of their milk from delivered sources for the period from July 1» 1951 to June 30* 1952 (see Table 3). Store purchases accounted for only # of the purchases while cash and carry outlets were responsible for BC# of the total milk sold to these consumer panel families. It should be pointed out that in practically all cases no differential existed between the price of store and delivered milk. However, in most instances milk purchased from cash-and-carry sources was three 191 cents per quart cheaper than delivered or store purchases. This differential coupled with the fact that three or four dairies had several retail sales outlets which specialised in cash-and-carry sales explains the relatively îiigh proportion of sales toy cash-and-carry sources. TABLE 5 B&LATION&hiP OF AMD QUANTITY OF MILK PURCHASED TO SOURCE OF PURÇRABE BY 101 CONSUMER PANEL FAMILIES, JULY 1* 1951 TO JOBE 50, 1952, LAN6IN0, MICHIGAN* j&jLBKl.j9;C__aLl]Lk;.. __ ^ ;iher@,"i%rchased _ Delivered Store _c;ash^ Carry.. Total quarts quarts quarts Homoge nl zed-Vit. D Homogenized-Plain Regular Pasteurised Jersey or Guernsey Total Percent 13,849 8,979 11,893 606 851 1287 675 1 3146 1817 4746 3 17,343 12,083 16,714 .... 610 34,727 73,5 2814 6.9 9711 20.6 47,250 100.0 %For details concerning the make-up and operation of the panel see James D. Shaffer, Methodological Basis for the Operation of a Consumer Purchase Panel. Thesis for degree of Ph.D. Michigan State College, Bast Lansing, (unpublished) A Study of individual purchase patterns for these 101 consumer© revealed that about 15 percent of these families purchased all their milk for the period from delivered source©* (Bee Table 4.) 192 TABLE 4 miKBÜSBl (BIT IMOGtGHL&iSJüWt; fT U lC D laiZLJC :FR()M ILAJUCKIS aaouac;a%3 cwp jPCGwi&àjsa; 333T ]L(& (icwi&oowu&a jPAJBusi, jrour 1, iiMn ICC) «rosis ;&(), jLsw&s;, i.jU9:s]3S(}, j&zxüii/Gj&Kt ^ "^'^Wouree of '%pohaa@ (none-cumulative) All milk All milk except for 1 week * M M g weeks « 1# «* #2^ « It M II H ^ » « 3 W «■ g * 16 10 6 9 6 8 3 3 0 0 0 2 5 B 0 0 z 1 Total number of families purchasing all milk except for 5 or less weeks 50 8 10 %n addition to these 15 families, 10 families supple­ mented delivered purchases one week in the year, while an additional 8 families made supplemental purchases in two weeks. This means that one-third of the panel families purchased practically all their milk from delivered sources. With the exception of 5 or fewer weeks when supplemental purchases were made, 50 families purchased all their milk from delivered sources. If the panel Is representative of the market this would mean that at least 50 percent of the consumers in the Lansing area do very little supplemental purchasing of fluid milk from other sources of supply. When it is considered that seasonal programs 193 may be in effect only from six to eight months out of the year# supplemental purchases may not be too damaging, especially from the majority of the people In the market* Those markets where practically all the fluid milk sold is delivered to the homes of the consumer would seem to offer great advantages as a suitable environment for iatra-consumer discrimination for fluid milk* At least initial attempts to formulate discriminatory programs should start at this point. From these markets experience could be gained that might be useful for handling more general situations, A city so small that one major dealer handled practically all the retail milk deliveries would be ideal for this particular requirement. In most instances route records are kept on individual consumers which would give the dairy all the necessary information and control that might be required to formulate satisfactory methods of intra-consumer discriminât ion. The %lform Delivered Purchase Pattern Most dairies consider route customers to have a standing order for a given kind and quantity of milk per delivery* These customers are carried on the route books as 1, 2# 3* etc., quart customers. Most dairies prefer customers to establish a uniform quantity per delivery# 194 siao© it saves time and expedites deliveries. However, practically all dairies make a practice of allowing the customer to increase, decrease or cancel the usual delivered quantities* 0om® companies go so far m to encourage people to place a separate order for each delivery. One method commonly used is for consumers to set out the number of empty bottles which corresponds with the number of quarts of milk that they wish to purchase for that particular day. This arrangement is often referred to as a bottle stop. Another method is for companies to give the customer cards with a list of products that the consumer can purchase from the dairy# Prior to the time the milkman calls, the customer checks the items and indicates the quantity of each product, including milk, that the milkman is to deliver. Many other methods are also used, ranging from the customer's placing of orders by telephone to various kinds of signals worked out between the customer and the milkman. From an administrative and operational point of view those customers who take the seme quantity of milk per delivery, with the possible exception of Irregularities in household activity such as vacations, sickness, guests, etc., present a purchase pattern for fluid milk that is X95 conducive to dléerlmln&tory pricing# Begerdiess of the usual amount of milk taken per delivery* these families coulé be offered the opportunity of purchasing an additional quart of milk per delivery at the reduced price* since most consumers are billed on a monthly basis, this would mean that with every-othar-day delivery* the family could purchase 16 quarts of milk above a base set for the family determined from the regular consumption pattern. The base for the family would become the usual quantity of milk purchased per delivery times the number of deliveries made during the month# For example, if a family purchased three quarts of milk per delivery and there were 16 deliveries in the month, the base for the family would become 46 quarts of milk. The base milk for the family would be purchased at the usual price, or the high price of a two-price system of discrimination. The 16 quarts of milk which were in excess of base allowances would be purchased at the lower price of the two price system. If the family normally purchased two quarts of milk per delivery, the base for the family would be 30 quarts per month which would be billed at the regular price while the surplus milk would still be restricted to 15 quarts which would be sold at the discounted price, 196 If r#*al* of substitution of the milk purchased at the lower price can be prevented from affecting sales at the regular price unfavorably, it would be advantageous to- allow families consuming larger quantities of milk to purchase additional milk at the discounted price. In other words, those f amilies having a base of 45 or more quarts per month could be permitted to purchase two additional querts per delivery instead of one, there m m Assuming fifteen deliveries during the month these families would be authorised to purchase 30 quarts of surplus milk at the discounted price# Families having a base less than 45 quarts per month would be restricted to 15 quarts of surplus milk, Restricting the quantity of surplus milk to 16 quarts per month regardless of the sise of the base that is es­ tablished for an individual family, has the tendency to discriminate against families who use large quantities of milk. If resale or substitution of surplus milk cannot be prevented from unfavorably influencing the quantity of milk sold at the regular price, restricting surplus milk may be a necessary part of the discriminatory program# Such market restrictions on a family basis, regardless of the quantity of milk the family purchased, could be justified on the same basis that retail stores often 197 tmpom restrlctloma on a per-customer basis* If a store conduots a sale on a particular itm, it is generally assumed that all persons desiring to participate in the sale can do so. Persons who never, or only occasionally, trade at the particular store are given the same opportunity to purchase Items at the reduced sale price as those who make large and frequent purchases* Often, if the sale is of a very unusual nature, the store will restrict the quantity of the item that each customer may purchase. Although the store's regular and large customers are not given any special advantages under these circumstances, they generally accept such sales policies without registering any complaint. It would seen that restricting surplus milk to individual families would not he fundamentally different in this respect from promotional sales conducted by retail stores. If a family regularly purchaees the same quantity of milk per delivery and never or seldom supplements these purchases from other sources of supply, no serious problems are presented for price discrimination as far as consumers are concerned* Records on these consumers will show the quantities that they normally purchase* A base can be established for such consumers with very little administrative effort. Allotments can be subjected 198 to all the eohtrol and restrictions that are required to operate suceessfully a two-prlo© systea of diserisiinatlon* Discounting supplemental purchases from other sources, evidence indicates that In many markets many customers do purchase the same quantity of milk per delivery# except for occasions such as vacations# illness# etc. For example# in Lansing# Michigan# one dairy estimated that well over three-fourths of its customers regularly purchased the â same quantity of milk. ' Another dairy Indicated that more than half of Its customers purchased the same quantity of milk per delivery. These families present a purchase pattern that can be subjected to price discrimination with a minimum of difficulty. If no other arrangements were possible for adding families with an irregular delivered purchase pattern# at least the families with uniform deliveries could be offered the opportunity of participating in a program of price discrimination. The potential consumers qualifying under this restriction would seem to warrant programs of price dis crimination in some markets even If it eliminated all consumers with irregular quantities per delivery. In these circumstances the opportunity to participate in a program of price ^ Information obtained from Interviews with retail sales managers of two large dairies in Lansing# Michigan. 199 discrimination could be used as a reward for making uniform purchases per delivery* There are some economic arguments that could be used to support such market activity. BircMse.Fmtternr AvolyiniP: Irregular Quantities per Delivers Although many consumers do purchase uniform quantities per delivery» other consumers find it to their advantage to vary frequently the quantity of milk they receive per delivery. Generally# the route books of the dairy indicate a standing order for these consumers. However» through some means the customer notifies the deliveryman to alter the standing order. If discrimination were limited to families with uniform quantities per delivery» these families would be eliminated as potential participants* This limitation would seem to be an unnecessary restriction to a market-wide discriminatory program. It is possible that those families purchasing Irregular quantities of milk per delivery offer greater possibilities of meeting the objective of discriminatory programs than do those families with regular purchases. Although it la difficult to prove empirically» It seems reasonable to assume that the price elasticity of demand may be more inelastic for families purchasing uniform quantities than for those who tend to fluctuate the quantities of 200 ïsiXk they purchase per delivery* la the case where a family u&ea uniform quantities of milk# it may he indicative that the habita# diets# menus# etc*, of the family are so adjusted to these quantities of milk that price incentives would be Ineffective as a means of stimiLating consumption. On the other hand# families that vary quantities purchased may signify that they are much more flexible in adjusting to quantity changes and price might be a factor in de­ termining the food consumption pattern for the family. Be that as it may# there seems to be no justification for unnecessarily limiting participation in discriminatory programs for fluid milk* It is granted at the outset that it would be impractical# if not impossible, to attempt to outline a plan that would cover all variations that might occur in non-uniform delivered purchases* However, moderate variations do not present insurmountable barriers* It has been shown that families purchasing uniform quantities of milk per delivery are given a monthly base predicated upon the quantity of milk per delivery and the number of delivery days in the month* Families that show variations in quantity per delivery could also be given a base. The consideration of several alternatives would seem to toe advisable in these circumstances. In all cases# it would 201 aeem that a study of past records Indicating the delivered purchase pattern for the family would be involved. Starting with families with small and occasional variations# a base could be established for each family to the point that great and frequent variations dictated that it would no longer be feasible to allow the partici­ pation of such families in programs of price discrimination* It is possible that families with some variation in con­ sumption could be encouraged to consume more milk which would be purchased at the regular price as well as additional surplus milk which would be sold at a discounted price* Assume a family had a standing order of three quarts of milk per delivery with the milkman* Suppose the family had three quarts of milk delivered every delivery day during the month except three at which time two quarts were delivered instead of three* It would seem desirable to give such a family a base predicated upon three quarts per delivery or 46 quarts per month* An allowance of 15 quarts of surplus milk could be made which would be sold at the discount price. In these circumstances some families may decide it worth their while to utilize the full base at the regular price in order to get the 15 quarts of surplus milk at the discounted price. This would mean that it might be possible to sell three additional quarts Z0& ©f milk at the regular prio® in addition to the eurplus Bilk sold at a dlsoouated price during the month. Where It is possible it would seem that many good argument* exlat for uaing the standing order with the milkman as a means of setting the base for the family, with small variations in quantities delivered. Occasional and small variations either above or below the standing order would not justify the trouble of searching any further for a possible base for these people. In all probability there will be more families who under-purchase their standing order than there are families who purchase more than their standing order would indicate. An average of such families would work in favor of the objectives of a price discrimination program. The use of the standing order as a base setting device for families with small and occasional variations in purchases would cause little confusion on the part of the consumer as well as on the part of the dealer. Most consumers think of consumption of milk in terms of a given number of quarts per day, per delivery, or per week. The standing order which they vary occasionally should be somewhere in line with their consumption pattern. Thus, when their base is set to agree with their standing order they would readily understand how it was calculated. In all probability 203 it would seam fair to them and should ancourage them to use their full hase allotment. Setting the base from the standing order would seem to solve many problems In the consumer's mind pertaining to the surplus milk. Consumers would be encouraged to think of the additional quantity of surplus milk In terms- of a fixed amount per period of time which would probably bring about more orderly adjustments in menus and meal planning. Establishing a base from the standing order even though the purchases of the family experience some variation would keep the administrative problems to a minimum for the dealer. Some check of the purchases In past months would be required. A range or limit could be set up to cover the extent of the variations permissible and then all families falling within this classification could be carried on & standing order basis. The routeman or clerical force could readily make the checks necessary for calculating the base and establishing the allowance of surplus milk. Special study should be given to the purchase pattern of some families one year or more preceding the inauguration of a discriminatory program. Often seasonal changes In consumption would be noticeable# and these should be given consideration in establishing the base. 204 Famille# will sometime# Increase or decrease milk purchases In the summer months. If it Is known what direction these adjustment© are apt to take, then the base could be set accordingly. Study of past record# may reveal Information that might be useful In handling problems such as vacations, guests, etc. It would be a mistake to attempt to be too precise about such things# However, If some obvious adjustments need to be made to make discriminatory programs more appealing or equitable to some families, they should be undertaken to prevent the loss of consumer good will as well a# to avoid defeating the purpose# of discrimination. It is possible that some small fluctuations in seasonal purchase pattern# would tend to cancel out or would not be severe enough to affect adversely the operation of a discriminatory program# Where this was the case, the fluctuation from the standing order could be neglected. However, where the fluctuation in purchase patterns for families was of a nature that it could readily be seen that establishing a base from standing orders would be Impractical# other arrangements would have to be made for establishing the base or the family would have to be excluded as a potential participant in programs of price discrimination# EÔ6 Gome famille# are not carried by the dellverymsa on a standing order basis. As it has been pointed out above, other families may vary their actual purchases so frequently and so irregularly that it would be impractical to attempt to use standing orders as a means for establishing a base. Rather than exclude these families from participating in a discriminatory program, it would seem desirable to attempt to find other means of establishing a workable base. It is possible that under these circumstances a base could be established by considering monthly purchases. If the family purchased rather uniform quantities of milk each month of the year* the average monthly purchases could be recognized as the base. Once the base is set for this amount* the family could be allowed to purchase an ad­ ditional allotment of surplus milk during the month at a discounted price. The customer could be informed that the dieoounted price on the surplus milk would only apply for quantities of milk purchased in excess of the base allotment. Through this arrangement the consumer would be encouraged to make full utilisation of the base milk in order to participate in the discriminatory program. In the event that past average monthly purchases showed wide fluctuation# from month to month, it would be well to consider the purchase pattern in considerable detail. The range of purchases for the high end low 206 months and their deviations from the average monthly purchase would beoome Important* especially during the months that a seasonal dis origination program might apply. It would always he possible to allocate such families a has® corresponding to the purchases for the high month. If the family responded to this offer the objectives of price discrimination would be more than fully met. Such a family would not only consume more milk at the discounted price, but in addition, it would greatly increase quantities purchased at the regular price. Price discrimination would become a successful sales techniques for these families, to the extent that they altered their purchase patterns to meet these requirements* It would seem that most consumers with a relatively high base would look upon an offer to participate in a discriminatory program with much misgiving. Mot only would they be inclined to refuse the offer, but probably more Important, some degree of animosity would be engendered by such tactics* If the fluctuations around the monthly average purchases have been rather consistent, especially during the months when price discrimination would become incorporated in the market, it would seem proper to es­ tablish the base so as to correspond to the average monthly purchases of milk for the period considered* 207 The advantages to be gained from sueh a proeedure are considerable» regardless of the fact that leakages may occur with some families* In all probability the customer could understand how the base was caleuleted and consider it fair* If the base Is accepted in good faith, the consumer would have more incentive to purchase the surplus allotment at the discounted price* Adminis­ trative effort on the part of the dealer or milkman would be reduced to a minimum through such practices* However, in some instances it will be obviously detrimental to the operation of discriminatory programs to allow specific families to use average monthly purchases as a base* These families would have to be excluded from the program or adjustments made in their average monthly purchases so a base could be established that would not yield un­ favorable results. The .Effect of Price Discrimination on Average Price The primary objective of price discrimination as proposed by this study is to Increase the sale of fluid milk* It has already been pointed out in earlier chapters that price discrimination is closely associated with successive rather than alternative action* Marginal price or outlay becomes the important motivation for £08 the consumer under aueh circuMstances. If am additional unit of the item can be purchased at a greatly reduced cost, consumers who are influenced by marginal values will find the purchase worth while. The lower the price of the marginal unit, the more consumers will be encouraged to make additional purchases* Since dealers selling fluid milk generally bill customers once a month, part of the influence of marginal pricing may be removed* Consumers may weigh the total quantities of milk received for the month against the total bill presented by the milkman* Part of this effect may be prevented by presenting two bills to each consumer; one showing the price and quantity of milk purchased at the regular price, the other showing price and quantity of surplus milk purchased at the discounted price* One bill could be used for both base and surplus milk, but it would be very desirable to list the items separately so the consumer would be aware of the discounted price on surplus milk. However, it is certain that many consumers will consider total expenditures for fluid milk in the light of total quantities of milk used, which will involve average price considerations* It is very possible that programs of discrimination can be formulated which would appeal to many consumers who are eonseious of average price. Buppoaa a family is purchasing om® quart of milk per delivery at a price of 25 seats per quart* let it be assumed that this family would use more milk if the average price were reduced, but at 26 cent# per quart it does not consider additional purchases worth while* For Illustrative purposes, let the differential between the consumer's base and surplus milk be 10 cents per quart* Under this arrangement let consumer be authorised to purchase one quart of milk at 86 cents per quart and an additional quart at 15 cents per quart# On an average price basis this would mean that the consumer would pay 20 cents per quaiü. For this consumer the differential between base and surplus milk is equal to a flat price reduction of 5 cents per quart* In most fluid milk markets flat price reductions generally amount to one cent per quart* Reductions of more than two cents per quart are very rare* Under usual market activity, at least two or three price reductions would have to occur before the consumer could purchase the two quarts of milk at an average price of EO cents per quart* If the consumer is purchasing B quarts of milk per delivery at 26 cents per quart, let an additional quart BIO ùt milk b# purchased at 16 oent® per quart* On an average cost ha®is this reduction would mount to three and one*thlrd cents per quart, which still result® in a considerable reduction In price la comparison to the price reductions usually found In the market. Even if a family were normally purchasing four quarts of milk regularly, the addition of a quart of surplus milk would amount to an average price reduction of two cents per quart* It is obvious that the greater the number of quarts of m ü k the family normally takes per delivery, the smaller will be the price reduction on an average price basis with a fixed per family allotment of surplus milk. If difficulties because of resale or substitution of surplus for base milk could be avoided, it would be advantageous to offer two additional quarts of surplus milk to consumers purchasing more than three quarts of milk per delivery. This arrangement would have the advantage of lowering the average price per quart for families that purchased larger quantities of milk. In these oiroumetances, if a family was purchasing 4 quarts of milk per delivery it would be allowed to purchase two additional quarts of surplus milk at a reduced price. Dfsing the prices postulated in the examples above, this would mean the consumer would pay $1.50 for the six quarts 211 ôî* milk which would result in an average price of 21-E/3 cents per quart or an average price reduction of three and ona*third cents per quart. It must be granted that many families using larger quantities of milk would be unable to use two additional quarts per delivery. Discounting adverse effects from reselling and substitution of surplus for base milk, it would seem advisable, nevertheless, at least to give large purchasers of fluid milk the opportunity of buying two additional quarts of surplus milk per delivery, lot only would it encourage increased use of fluid milk in the market, but those families with large purchases, who could use additional milk and were inclined to be Influenced by average rather than marginal prices would be given an added incentive to make additional purchases, Price Discrimination and Relative Increases in Consumption Restricting the purchase of surplus milk to a specified amount per family discriminates against families purchasing large quantities of base milk# However, such Inequities may be necessary to prevent adverse effects upon the sale of milk at the regular price# It is possible that these restrictions may bring about some desirable results in favor of programs of price discrimination, even though 212 SOM© inequities seem unavoidable* In many, if not most, fluid milk markets the majority of the families use less than 46 quarts of milk per month. This is borne out by consumer panel data where it was found that for the year July 1, 1961, to June 30, 1962, 64# of the 101 families used fewer than 30 quarts of milk per month* Twenty-six percent used 31 to 60 quart® per month while 21# of the families used more then 61 quarts of milk per month. Til® preponderance of families taking smaller quantities of milk is also shown by information covering only delivered g milk for a particular dairy. In this case it was estimated that about 50 percent of the delivery stops were for customers purchasing one and two quarts per stop. About 40 percent of the stops were made to families purchasing three or four quarts per stop, while about 10 percent of the dairy's customers purchased five or more quarts per delivery. Restricting the quantity of surplus milk on a family basis favors small families. This advantage in favor of small families, however, would tend to encourage additional milk consumption at the point Where it would bring about the greatest relative increase in the market. Part of the increase may be due to the indivisibility of a quart bottle Information obtained from a personal Interview with retail sales manager for Meatherwood Dairy, Lansing, Michigan, E13 of fluid milk. For example, assume a family normally purchases one quart of milk per delivery, or 16 quarts per month. Dhder price discrimination let the family be authorised an additional quart per delivery of surplus milk at a discounted price* It had already been shown that on an average price basis this family gets a better bargain than those families taking larger quantities of milk* If this family does purchase the additional quai*t of surplus milk as a result of price discrimination, it will readily be seen that the family has increased its fluid milk consumption 100 percent* If a family uses two quarts of milk per delivery, let the quantity of surplus milk at a discounted price still be restricted to one additional quart per delivery. If the family purchases the surplus milk, a fifty percent increase in fluid milk consumption has occurred for this family m a result of price discrimination. However, if a family normally purchases six quarts of milk, the purchase of an additional quart of surplus milk only involves a 16-2/3 percent increase in consumption of milk. It is obvious that the greatest percentage increase in consumption of milk on a family basis is registered by families purchasing Small quantities of milk who can be encouraged to purchase an additional quart of discounted milk. If surplus milk 2X4 is limited to a given quantity per family, the families purchasing small quantities per delivery receive the greatest advantage on an average price basis. In other words, those families which would show the greatest per­ centage increase in consumption If they purchased an additional quart of surplus milk are also given the greatest incentive to make the purchase of the additional quart* When one considers the preponderance of families making small purchases of fluid milk, this particular aspect of price discrimination may become very effective as a sales tool to encourage the increased use of fluid milk in the market, Price Discrimination and the General Movement in Milk P The nature and characteristics of the market should be considered in establishing the base for individual families* The anticipated changes in price that might occur in the market should be given proper weight, as well as past events and relationships. For example, if the trend in fluid milk prices were downward, it would seem that a much more liberal attitude could be taken toward discriminatory programs than if there were a tendency for milk prices to rise. Bases that permitted 216 more substitution of surplus for regular milk eould be established* The result would be that the consumers of the market as a group would be getting their milk at a lower average price* It is possible that a discriminatory program could be formulated to reflect general supply and demand conditions in the market by adopting various policies with respect to price differentials and establishing bases for individual consumers* If market conditions indicated that a uniform price reduction in fluid milk was in order for the market in the near future, families eould be given low bases and allowed to purchase extra quantities of surplus milk which would act as a quasi-decrease in the price of milk* If a uniform price reduction were still contemplated after the termination of the discriminatory program, price discrimination would have acted as a prelude for the marketwide uniform price reduction and many of the consumers would have partially adjusted to the new uniform price* Consumers would be encouraged to increase milk consumption as a result of discriminatory pricing* If these consumers had not been given the opportunity of participating in a very liberal discriminatory pricing program, it is possible that a price reduction on a uniform basis would not be effective in encouraging them to use more milk. In other 216 words, it might bo possible to condition consumers through discriminatory practices to respond in a desired direction to adjustments that ere expected under a flat or uniform price reduction. Programs of seasonal price discrimination could have considerable flexibility and could be used to supplement objectives which adjustments la uniform pricing are designed to achieve, FM.m_.M#crMm&tAon._I#volvln&..._&tore Purchases of Milk The proposed plans for price discrimination presented above assume that most of the fluid milk in the market is delivered to the homes of the consumer. It was also assumed that it was not a common practice for consumers to supplement delivered purchases with milk purchased at the store. 10 Purchase patterns involving delivered milk have advantages for price discrimination over other sources of supply available to the consumer. However, in many markets more milk is sold through stores than is delivered to the homes of the consumers. In markets where both delivered and store milk are common consumer sources of supply, policies involving price discrimination would encounter much opposition unless plans were formulated Store purchases are meant to also include purchases from milk depots, cash-and-carry sources, etc. E17 to c o w r the different method# of purchase* Daless some method of stamps or coupons were used, it would seem impossible to be able to subject purchases from the store to the same control and limitations that can be achieved with delivered purchases. For practical purposes* without resorting to stamps or coupons* multiple sales would be about the only alternative for a market wide discriminatory program involving store milk. At best such practices would lack many refinements that could be accomplished with delivered milk* For example with every two quarts of milk the consumer purchased at the regular price a third quart could be sold at the discounted price* Since paper cartons are becoming common containers for store milk, the three quarts of milk could be wrapped together with a paper band. The multiple unit could be advertised and displayed as a special sale on milk similar to that found for other commodities. Under this arrangement a person who had planned to purchase only two quarts of milk might be encouraged to purchase the additional quart at the reduced price. The possibility of substituting surplus for regular milk would always be more of a problem with store than with delivered milk. One method of keeping this objection­ able feature to a minimum would be to find the most common S18 quantity of purchama for the market* two quart® per purohaee* Assume that it were The base quantity could then be established at three quarts at the regular price and the fourth quart at a discounted price. Through such pricing methods, consumers would be encouraged to purc?iase an additional quart of milk at the regular price plus the surplus quart at the discounted price. Since consumers would still be able to store .milk over a period of time, it would be possible for the consumer to substitute the surplus for the regular milk. However, if consumers had more milk in their refrigerators which was readily available to them* it seems that more people would use greater quantities of milk* People who purchase milk from the store frequently and in small quantities are apt to find on many occasions that their supply of milk is exhausted and will substitute other things in the diet rather than exert an effort to make additional purchases * If consumers are motivated to make adjustments in consumption patterns because of changes In relative prices, then new uses will be found for milk which will replace other food items. Guch a practice will tend to minimise the substitution of surplus for base milk* It is possible that families whose price elasticity of demand is elastic would even Increase their use of regularly priced milk under some systems of price discrimination. 2X9 ■Q.QUB.Qns,.,,in. frojstramt of. Prim . PisG rlm im tlon The lack of control over consumers who piii'chsse milk from stores may be a serious limitation to discriminatory practices in many markets. Rather than allow the discount on surplus milk in monetary terms, it is possible that the discount could be given through coupons or stamps which were redeemable in prises or merchandise, Since children generally consume more milk than adults, the rewards in the form of merchandise could be directed toward them. Very desirable and worthwhile prises could be given as a reward for saving and collecting coupons. Various systems of allocating the coupons could be employed, One method would be to have a multiple package for base and surplus milk with a coupon or stamps attached to the package, Suppose the package contained two quarts of regular milk and one quart of surplus milk. The value of the coupon could be determined by the discount available on the surplus quart. Families would then be encouraged to purchase more milk in order to obtain the coupons and thus the prises. It would be possible to date or number the coupons and give added incentive to families who purchased frequently and in large quantities. The marking of the zzo coupons could te® used as a check to prevent or discourage families from surrendering coupons that they might obtain from a neighbor or friend rather than with the purchase of milk for their own use. Ooupcns could tee restricted to the multiple packages, so that consumers would be encouraged to purchase greater quantities of milk per purchase. Suppose the coupons or stamps were worth ten cents redeemable in merchandise. If a family made 16 purchases of the multiple unit during the month, it would tee entitled to merchandise which was worth #1,60. If 30 purchases were mad®, a selection could be made from merchandise worth twice as much or $3.00* If the coupon contest continued from six to nine months, it would tee possible for families who mad® 16 purchases per month to earn prises valued from #9,00 to #13,60* Families purchasing 30 multiple packages per month could surrender their coupons for prises or merchandise worth twice this much, or from $18 to $27 for the season. If the merchandise used for prises were obtained and distributed on a wholesale basis, the retail margin on the various items could also tee used as an incentive for con­ sumers to participate in discriminatory programs for fluid milk, Assuming merchandise listed at retail could tee discounted 25 percent, this would mean that families earning coupons valued at $10 could surrender them for 221 merchandise worth #13,53. Familles having coupons valued at $87 could surrender them for merchandise worth $36. In other words, a family that purchased 870 quarts of surplus milk at 25 cents per quart, or one additional quart per day for nine months would make an additional outlay of $67.50 above their usual expenditures for milk. In addition to receiving 870 quarts of milk for that outlay, the family would receive #36.00 worth of merchandise. Families having coupons worth |10 would have to spend #25 for surplus milk - assuming milk was 25 cents per quart and a differential of 10 cents per quart between base and surplus milk. These families would receive 100 quarts of surplus milk or a little more than 16 quarts per month for six months. In addition to receiving this extra surplus milk* the family would receive merchandise valued at $13,33. It would appear that such an offer would be attractive to many families. Encouraging sales of surplus milk through stores by means of coupons which are redeemable in merchandise would seem to have some advantage over a cash discount on surplus milk. In the first place, the sale of many items found in food stores is promoted through the use of coupons. Many consumers accept this type of sales promotion and where they are inclined to participate in 222 $iîOh programs very little consumer education would be required. Secondly, coupons could be arranged and accepted In a given order and quantity so that the undesirable effects of substitution and/or resale of surplus for base milk would be minimised* Last, but not least* the pro­ motional campaign could be conducted without altering the regular retail price, which often causes considerable suspicion on the part of the consumer and is looked upon with disfavor by many people associated with retail marketing, The possibility of using some type of coupons or stamps redeemable in merchandise should be considered for delivered milk as well as for store milk. Even though programs of discrimination for delivered milk make monetary discounts feasible, it is possible that the objectives of price discrimination could be more readily achieved through offering incentives in merchandise and prises. If it can be established that practically all the consumers are unresponsive to price changes, regardless of the amount of the relative price change or the pricing pattern followed, then the use of coupons should certainly be considered as an alternative approach to price discrimination. The advantage delivered purchase patterns have over store purchase patterns when using monetary Incentives would 2S3 not be negated by using coupons and merchandise as a method of discrimination. In fact, one of the major concerns of dealers handling route sales is that sales techniques involving price changes lead to cut-throat practices in the market# This objection could be met, at least partially* by using coupons and merchandise and leaving the retail price unchanged. The sales appeal and the promotional work that could be built around merchandise and prises might be used, as an additional sales lever. The possi­ bility of using the retail margin on the merchandise as an additional reward for using surplus milk should be attractive to many potential customers. The programs involving coupons redeemable in real goods that might be formulated as discriminatory techniques are too numerous and varied to justify elaboration in this study. This type of activity is commonly used in promotional campaigns involving many different products. The variety of desirable and valuable Items that could be offered as incentives due to a wide differential in a two-price system may make this type of sales technique more effective as a means of increasing fluid milk sales than monetary Incentives would be, The important point to consider is that the present pricing structure in some markets permits programs to be formulated that would appear to encourage and promote 224 th@ sal® of fluid milk. Within the given m&i'ket setting those programs should be pursued which will be the most effective in increasing the consumption of fluid milk. The problem lies in determining the nature and character­ istics of the program to meet this challenge* T M Hi.®.,of Alternative_ Dairy Products in Discriminatory This study has been primarily concerned with fluid milk. The theoretical analysis and suggested plans of discrimination have been specifically focused on bottled fluid milk. The analysis has shown that the possibility of the consumer's substituting or reselling price-discounted surplus milk for milk sold at the regular price is a serious limitation to programs of price discrimination. It remains to be shown now that if this limitation precludes the use 0Î bottled fluid milk in a discriminatory program, other alternatives are still open which can, at least partially, avoid some of the undesirable aspects of substitution. These alternatives consist of using fluid cream, chocolate milk and/or other dairy products instead of bottled fluid milk as the object of dis oriminat ory practices* The use of these alternative products would be restricted to those markets that specify that these products be manufactured E26 from Glass 1 milk. Host mai'kets require that chocolate milk be classified as Class 1 milk. Many markets stipulate that only Grade â milk shall be used In the production of fluid cream. 11 Although other dairy products may be required to be manufactured from Grade A milk, the dis­ cussion will be confined to chocolate milk and fluid cream as possible alternatives for programs involving price dis­ crimination. Chocolate Milk Chocolate milk has found favorable acceptance in some markets as a summertime beverage. This particular character* istlc makes it ideally suited for programs of seasonal price discrimination. Very little is known about the substituta­ bility that might exist between chocolate and fluid bottled milk. Since both fluid and chocolate milk are primarily used as beverages, it seems reasonable to assume that the degree of substitutability might be fairly high. tendency is shown in a study conducted by Hadary. This 12 This fluid milk and cream report. Oo. Git.. p. 2-5. This report shows that about 6C% of the cities reported dealers paying the same price for milk used for cream as that used for fluid milk. Gideon Hadary, "The Relationship of Chocolate Milk to Total Fluid Milk Consumption, " Journal of Farm Economics. Vol. S7 (1945),pp. E10-E15. 826 Study reports that, On the average, of the fluid volume represented by a quart of chocolat® milk, 67.5 percent was a replacement of whole milk, 7 percent was flavor and the remaining 85.5 percent represented an increase in the volume of fluid sales. As far as the distributor alone is concerned the volume represented by flavoring also constitutes an additional sale. On this basis the 96 million gallons, or 886 million pounds of chocolate milk consumed in fluid form in the U.S. in 1948 represented; (a) 57,798,000 pounds of chocolate flavor (b) 557,880,000 pounds substitute or replacement for whole milk . (c) 810,586,000 pounds increased fluid sales Although this study indicates a fairly high degree of substitutability between fluid and chocolate milk, it is certain that this substitutability is much less than that which would exist between discounted surplus and regular milk, for all practical consumer uses, discounted surplus and regular base milk can be considered as one product, which, by definition, implies perfect substitutability. It has been shown that through various pricing policies 8 distinction is xaade between surplus and bas® milk, although this division is artificial and market-imposed. Through programs of price discrimination certain controls and checks are available to limit the consumer from freely substituting price discounted surplus milk for regularly Ibid. 227 priced bas© milk. Hadary has indicated that when the consumer could freely substitute chocolate for fluid milk, the degree of substitution was much less than perfect substitutability* This suggests that by imposing some mai'ket restrictions on consumers to limit further the degree of substitutability, chocolate milk has possibilities as a satisfactory component of discriminatory pricing programs* One severe limitation to the use of chocolate milk as a product for price discrimination is that in most markets seasonal consumption is highest during the late spring and summr months. It would be impractical, if not Impossible, to formulate discriminatory programs so as not to interfere with this usual seasonal pattern. Intra-consumer discrimination Involving s two-price system for chocolate milk alone would have very limited possi­ bilities* In many markets, however, the sale of chocolate milk constitutes a very small proportion of the total fluid milk sales. This is indicated by consumer panel data for the city of Lansing, Michlgen*^^ Information covering 101 families showed that chocolat© milk accounted for Unpublished data from Consumer Panel, Op * Git* 228 only 2% of the total fluid milk volume for these faMllee fro® July 1, 1951, to June 30* 1952. Through liKiting priee-dlBQOtmted chocolate milk to certain families that complied with restrictions placed on the purchases of fluid milk, it seems possible that the sale of regularly priced bottled fluid milk could be promoted at the same time discount pricing was promoting the consumption of chocolate milk. In other words through multiple packaging at stores and limitations placed on consumers purchasing delivered milk, some consumers might be given an incentive to increase regular fluid milk purchases in order to participate in a bargain for chocolat® milk# Chocolate milk used as a companion product, or tiein sale, for bottled fluid milk could be promoted as a summertime beverage. Through this technique the price of fluid milk would remain unchanged and some of the difficulties of a two-price system in valuing the same product would be avoided. The possibilities of substituting discounted chocolate milk for regular milk would not be so great as substituting price discounted surplus milk for milk sold at the regular price. Many consumers may prefer chocolate milk to fluid milk as a summertime beverage. As such, it may be that chocolate milk would be substituted for other non-milk beverages, rather than 229 for fluid milk# Some of these characteristics favor using chocolate milk as an alternative in programs of price discrimination, where it is impractical to use pricediscounted bottled fluid milk# It has already been pointed out that many markets require that fluid cream be classified as Glass 1 milk# This requirement means that in some markets the price differential between Class 1 end manufacturing milk is available for promoting the sale of fluid cream. It seems reasonable to assume that very little substitutability exists between fluid milk and fluid cream* The two products ere generally used for different purposes, although it must be granted that some overlapping in uses is possible. Most studies Show that the price elasticity of demand for fluid cream is much more elastic than that for fluid mill:# A considerable reduction in the retail price of fluid créais may therefore be an effective method of increasing the consumption of fluid cream, Promotional activities involving fluid cream could be centered around several seasonal factors. Fluid cream could be promoted as a seasonal product for fresh fruits and, berries. The possibility of increasing fluid cream 230 coELSumptiODi In this area would seem to tee veiy great. Promoting recipes and formulae requiring fluid cream and. milk for home-made ice cream and frozen deserts would tee another area that should tee exploited. The possibility of encouraging families to prepare and mix milk drinks such as malted milks, milk shakes, etc., in the home would seem to tee a rewarding endeavor. It is true that these activities would involve the purchase of some equipment and mixers to handle this task properly. However, many families may enjoy adding new tools and gadgets to their collection of kitchen aids. With the advent of television and home entertainment better and easier ways should tee forthcoming for preparing milk drinks to meet the competition from other beverages in the home. The ease and convenience of serving other non-milk beverages in the home offers real competition to milk drinks unless better and cheaper ways are found for preparing popular beverages made from milk and dairy products. The use of fluid cream in a discriminatory program seems somewhat limited. However, the relatively low substitutability between fluid milk and cream suggests that it is an opportunity that should tee exploited. Through tie-in sales, multiple packaging, and restrictions on delivered purchases, it is possible to increase the 231 sale of fluid milk while promoting the use of price discounted fluid cream# The pricing structure in some markets favor® the use of fluid cream as a component of a discriminatory program# If a two-price system of dis­ crimination for fluid milk is impractical, the alternative of using any or all other dairy products should be considered where the pricing and marketing structure permits this course of action* PmCTIGAl mOBLSm IRVOIVED m IRITIAIIRO AMD OPmAIIMG DiDORIMlMATOaY PROGRAMS FOR FLUID MILKl Coopérative Effort Required The whole nature and scope of the plans of price discrimination for fluid milk as presented in this study is theoretical and involves many problems that cannot be anticipated. The lack of empirical data to prove or disprove some of the fundamental propositions upon which the proposed programs are founded makes definite conclusions Impossible. It has been the purpose of this study to search ^ Material for this chapter was largely drawn from personal interviews with the following personsî Fred Axelson, Plant Manager, Lansing Dairy# Lansing, Michigan George Irvine, Market Adminletrator for Federal Milk Order, Detroit, Michigan Leo Harnett, Routeman, Lansing Dairy, Lansing, Michigan Earl Hemingway, Boonomist, Detroit Creamery, Detroit, Michigan Roland Jackson, Retail Rales Manager, Reatherwood Dairy, Lansing, Michigan R, G, Jenks, Official, Retail, molesale and Department Store Division of the C.X.Q., and Routeman, Artie Dairy, Lansing, Michigan Edward Robinson, Sales Manager, Lansing Dairy, Lansing, Michigan Nelson Rouse, Manager, Mason Dairy, Mason, Michigan Howard Dimmons, Secretary Manager, Michigan Milk Producer's Association, Detroit, Michigan Gar Wagner, Assistant General Manager, McDonald Dairy, Flint, Michigan 233 for and perhaps to speculate about the Ideal conditions for a successful program involving intra-consumer quantity price discrimination as a means of increasing fluid milk consumption* in general* and particularly during the period when the seasonal increase in production occurs. This study has been based on the notion that the underlying determinant of success for any discriminatory program involving fluid milk is the consumer *s favorable acceptance and endorsement of such programs, Even if it be assumed that a satisfactory method of intra-consumer seasonal discrimination can be discovered for a particular market, many practical and difficult problems would have to be worked out between the producers, dealers, routemen* unions, etc. Discriminatory programs as proposed by this study involve cooperative effort, and in the past many of these groups and organisations have not shown too much inclination to work together. Unwillingness of routemen to participate in a discriminatory program Involving marginal cost pricing for surplus delivered milk could be just as detrimental in preventing the inauguration end operation of discrimi­ natory programs as lack of consumer acceptance. However, if it can be shown that all groups stand to receive some economic benefit an atmosphere is presented for providing E34 the ineentlv® to join hand© and settle differences* This chapter will he devoted to some of the practical problems that mist be solved to provide a suitable environment for intra-consumer discrimination for fluid milk. Gpmmri5Am._..b.etwmn_.Reli#f-Milk Programs and Intra-Consumer Prie#. Discrimination The relief-milk distribution programs found in some cities during the past depression substantially required the same concessions and agreements on the part of producers and dealers as postulated by this study* Not only is there similarity between the conditions applying to producers and dealers* but relief-milk programs were also based upon consumer discriminatory practices. The big difference between the rellef-mllk programs and the plan this study is considering is that relief-milk programs were based upon inter-consumer or class discrimination, wiiereas tills study includes aspect© of both Intra- and inter-consumer discrimination. Most relief-milk programs ware limited to low-Income families. One of the first recorded attempts at inter-consumer discrimination involving relief-milk was initiated in o lew York City in 1934. The most complete and comprehensive B Alan MacLeod, et al., "What Makes the Market for Dairy Products," Agricultural..Bxbeiimmt,..D.t.gtioii. University of Wisconsin, Madison, Wis», Bulletin 477, Sept. 1948, 235 program involving rallof-mllk was carried on In six large cities, (Boston, Chicago, Kew Orleans, Mew York, St* Louis and %shington, D. 0.) all of which were operating under federal milk order*.^ The relief-milk program* in operation in these cities were undertaken by the U* B# Department of Agriculture in cooperation with milk producers, dealers and city welfare agencies* All the programs operating in the various cities were designed to provide low-inoome and needy families with milk at greatly reduced prices as compared to prices of milk sold through the usual channels. Prices paid to producers were considerably below those prices paid for milk going into regular fluid milk channels, but slightly higher than prices paid for surplus milk* Dealer*® margins were less for relief-milk than for milk sold through the regular channels. This reduction was partly because of fewer services performed and partly because the dealer* were willing to handle the additional volume of business occasioned by rellef-milk for a lower margin than for comparable services performed in connection with the regular trade. Considerable differences were found to exist between the margin* for rellef-milk and ^ w. a. Sullivan, The Relief-Milk Distribution Program. U. 8. Department of Agriculture, BAS Mimeo, November 1947, See also, Alan McLeod, Oo. Cit.* p. 37. 236 regular fluid milk, la some cities the margin for home delivered rellef-milk was from two to five cents per quai't cheaper than for regular home delivered milk* In all cities quantity restrictions were placed on the amount of milk that participating femllles could receive (usually a per capita allotment) to prevent resale to friends and neighbors* Purveys conducted with families receiving reliefmilk showed that low income participating families increased their consumption of fluid milk substantially when it was made available at greatly reduced prices, This increase applied particularly in maikets where the per capita consumption of fluid milk was low before the initiation of the programs, and where limits were not too restricted with regard to the permissible amount of milk that each family could receive* there was not a consistent inclination on the part of participants to reduce expenditures for m H k with the Inauguration of the rellef-milk program. On the contrary, in Washington, D* C* participants Increased their per capita expenditures for milk about 40 percent with the introduction of cheap relief-milk* It is interesting to note that in four markets surveyed the increase in consumption of fluid relief-milk was accompanied by a decline of about 30 percent in the amount of evaporated milk used* It has often been 237 maintained that evaporated milk la a close substitute for fluid milk* These results seem to confirm that belief. When the combined consumption of evaporated and fluid milk was considered, results showed that without exception the combined consumption of the two products exceeded the pre­ program consumption. In Washington, D* C*, the combined consumption for participants showed an increase of 90 per­ cent over pre-program consumption figures* Belief-milk programs cannot be used as a basis for justifying intra-consumer price discrimination programs. In all but one market, sales of relief-milk constituted less than five percent of all milk delivered to the market* À comparison between the two programs, however, indicates some interesting possibilities. In the first place it indicates that it is possible for producers and dealers to set aside their differences and suspicions and join in a cooperative effort, if collectively and Individually they have an opportunity for mutual gain. Secondly, the results show that it is possible to increase consumption of fluid milk as well as to divert milk from lower uses into fluid milk uses if relative prices as well as other circumstances favor this course of action on the part of the consumer. Both of these considerations are fundamental to discriminatory programs foi’ fluid milk as outlined in this study. S56 ......Producer8.In Price Pis erimination The differential between fluid and manufacturing milk prices can be the motivating force for seasonal programs of intra-consumer price discrimination. In many markets agreements and contracts between dealers and producers prevent the use of fluid milk for bottling purposes at manufacturing milk prices. Discriminatory programs using the price differential between fluid and manufacturing ©ilk would require alterations and changes in producerdealer agreements. Gome individuals feel that producers would not be willing to accept this modification to their present pay plans. Agreements preventing dealers from using milk for bottling purposes and paying for it at manufacturing milk prices are designed to yield producers a greater return for their milk. Would it be possible for dealers to sell some of the surplus fluid milk at the regular price and pay producers manufacturing milk prices for it? The possibility of dealers attempting such practices exists. However, it would seem that means are available to guard against this practice in markets where price discrimination programs might be practical. E39 Most markets are operating under some variation of oXassifi©d-use plans* Ail federal market orders require dealers to aoeount for the milk they use under classified us® plans* The market administrator is empowered to audit the accounts of dealers to determine how the milk is used. From this audit information is obtained to levy a charge against each dealer for the milk he uses based upon the disposition made of the milk. The problem of accounting for surplus milk sold under a discriminatory program was presented to a market adminis­ trator, of a federal milk order. ^ He felt that the accounting for surplus milk for discriminatory programs could be handled along with the accounting for milk used for other purposes. H® pointed out that it would require some extra administrative effort but felt that it would not be prohibitive* He was of the opinion that spot checks could be made of route books or other records which could be used to verify dealer's accounts covering surplus milk. Past records of fluid milk sales and their variations over a given period of time could also be used as a rough check to verify the accuracy of the dealer's records covering surplus milk used under a discriminatory program. ^ George Irvine, Market Administrator, Federal Milk Order, Detroit, Michigan. 240 The problem of accounting for surplus milk under any variation of a classified use plan is not fundamentally different from accounting for the milk used by the dealer in the absence of discriminatory programs, About the only modification that is necessary is that another possible classification is established for fluid milk. The danger of dealers using fluid surplus milk at manufacturing milk prices and selling it to consumers at the regular price would seem to be no greater than dealers indicating they used milk for making butter, when actually they bottled it and sold it at regular fluid milk prices* The oppor­ tunity for dealers to misuse or appropriate milk to be used for discriminatory purposes for their own advantage is present, However, methods seem to exist for checking classified use plans for dealers to prevent leakage of manufacturing milk into fluid milk sources. There is no reason to assume that surplus fluid milk used in a price discriminatory program could not be handled in a similar way. If producers can be assured that dealers can be prevented from isisclassifying surplus fluid milk for their own gain, the question of how a discriminatory program could benefit producers still remains. If there is no gain whatsoever to producers from the program, 241 even If there is ao loss, then it ©ay be assumed that they would be unwilling to participate in such a program* Within the framework of this study, It is assumed that producers would receive the same amount of money for their excess fluid milk if it were used in a discriminatory program as if it went into manufacturing uses. In other words, the programs of price discrimination set fofth in this study offer no direct benefit or gain to producers. It is possible to provide for prices slightly higher than manufacturing milk prices for milk used in a discriminatory program, in order to show some direct gain for producers. However, the importance of widening as much as possible the differential between milk sold at the regular price and milk sold at the discounted price precludes attempting to offer producers any direct advantage from discriminatory programs* This study contends that indirect benefits that should accrue to the producers as a result of discriminatory programs fully justify their wholehearted support and participation in such programs* If discriminatory programs can divert to fluid milk uses some milk that would normally find its way into manufacturing products, then it can be assumed with a fair degree of accuracy that the prices 242 for the manufaetured products will be higher than they otherwise would have been. Indirectly these price adjust­ ments benefit Oracle A milk producers since some of their surplus fluid milk is generally used for manufacturing purposes* This may be a very dubious benefit to offer a group of producers who feel their actions could have no effect on the market * However, it would seem to be a move in the right direction even if it is only a means of showing the public that the producers are willing to do those things that ere at their disposal to encourage consumption of fluid milk. Gome consumers may be encouraged to continue their fluid milk consumption throughout the year when discrimi­ natory programs are discontinued on a seasonal basis. Tills increase in consumption would represent an expanded market for fluid milk sales and thus a better market for Grade A milk during the season of the year when discriminatory practices were discontinued. The increased consumption of fluid milk that might occur at the termination of the discriminatory program for the year would represent a delayed direct benefit to producers. If increased con­ sumption at that time were fairly substantial, producers would realise an important gain from participation in programs of price discrimination. 243 It l8 possible that a base end sui’plus plan for individual consumers can be devised to encourage con­ sumption of some additional milk at the regular price as a prerequisite for participation in price discounted surplus milk. Some families may have irregular purchase patterns that would justify establishing a base slightly above the average monthly quantities purchased which would give them an incentive to increase their consumption of base milk* Even the families with fairly uniform purchases could be given a base that would encourage increased consumption of milk at the regular price. A check of route books for one dairy revealed that its customers usually altered their standing order by taking less milk. For example, if a customer was carried as a four quart customer per delivery, it was much more common for the family to modify the order by taking less than four quarts than by taking more than four quarts, Such a family would probably be willing to accept a base predicated upon four quarts per delivery. If the family participated in the discriminatory program with this base, then it is readily seen that the consumption of fluid milk at the regular price is greater than it would be in the absence of price discriminâtion. 6 McDonald Dairy, Flint, Michigan, 244 Aa official from a producer's organization claimed that in som© markets it had been their practice to allocate a given amount of milk to some dealers at Glass 1 prices without any restrictions being placed upon the use made of regular or excess milk, ^ In other words the dealer could bottle excess Grade A milk which he purchased at manufacturing milk prices and sell it as he saw fit. This arrangement is similar to that suggested for dis­ criminatory programs, except that accounting would indicate the actual amount of milk sold at the regular and discounted prices under discriminatory programs. This study contends that producers should not expect or hope for large and direct gains from discriminatory programs. Such an attitude would certainly defeat the purposes of price discriminations m study* outlined in this Bases for consumers should not be set so as to attempt to extract the maximum amount of expenditure for milk at the regular price, Rather, they should be es­ tablished on a basis which would be fair to the customer and still not defeat the purposes of the program, ■If producers can be assured that they will not lose the sale of any Grade A milk at fluid milk price, then they have G Howard Gimmons, Michigan Milk Producer's Association, 245 nothing to lose by participating in discriminatory programs. Producers should not require large imcedl&te and direct returns as a requisite for their participation in the program. Dairy products of all types ere meeting increased competition from substitute products, Many producers feel obliged to do anything and everything within their power to meet this competition as a matter of survival. It would seem that such producers should accept and partici­ pate in programs of discrimination even if it can only be justified on a long-run indirect benefit basis. Frice DiBArlmlEmtlon..and._.th@ Dealar The role of the dealer in discriminatory programs for fluid milk is paramount. Although producers, routemen, and others, must lead a cooperative hand to efforts directed toward price discrimination, nevertheless, the problem of organising and administering discriminatory programs would largely fall to the dealers* The proposed plan of price discrimination as outlined in this study was presented to officials of several different companies. It was interesting to note that one of their first reactions to the program was a concern for the way in which the operation of the program would affect the state of the competition and activity in the 246 market, It was apparent from the reaction of the various persons interviewed that a type of oligopoly existed in the various markets. This state of affairs is aptly described by Fellner a® "what I am willing to do depends on what I assume the other party's response will be, and at the same time, what the other party is willing to do depends on what he thinks my response will be."^ This type of reaction is probably characteristic of many, if not most, fluid milk markets* discriminatory practices. It marks a limitation to Even if workable program© could be formulated for consumers, dealers may fear that relations among themselves would not be as satisfactory as those before the inauguration of discriminatory programs* Many fluid milk markets have had considerable instability, which most dealers dislike* Through a process of quasi- agreement or live and let live, many dealers have es­ tablished relationship® that are respected and honored to the point that they will not violate them. In one market, it was pointed out by an official of one company that probable competitor reactions were always considered before undertaking new promotional and sales campaigns. He indicated that although the market was large, practically all of the business was concentrated ^ William Fellner, Competition Among the Few. Alfred A. Knopf, New York, 1949, p* 13. 847 the hands of three or four companies* Relationships among these eoiapanies were such that each company could pursue certain sales policies without much reaction from the rest of the companies. In other words, one company specialized in wholesaling milk to retail outlets while another company was primarily concerned with route sales to a certain class of people in a particular part of the city. Each company could pursue the opportunities open to it in its respective speciality without expecting much retaliation on the part of other companies* However, any sales activity by these companies outside of their par­ ticular specialities was promptly discouraged by retalia­ tory measures on the part of those companies that might be adversely effected. It was pointed out that under these arrangements it was possible for all the companies to earn a margin for profit. However, it was felt that this margin was not great enough to encourage the entrance of new competition in a market that was served by the existing companies. The person interviewed expressed concern over the fact that discriminatory programs might adversely upset the relationships existing among the dealers in the market which had been built up over a considerable period of time. It was suggested by this individual that discriminatory programs might be undertaken 248 i» some markets by dealers who did not feel the existence of such restrictions to their promotional and sales activity* An interview with a person associated with a small dairy revealed that it might be undesirable for his organisation to participate in discriminatory programs unless it was a general market-wide activity* This person pointed out that the capital structure of his organisation was such as to make it undesirable to enter into un­ necessary retaliatory competition with larger organisations. Again such a feeling indicates the oligopolistic nature of many fluid milk markets and the problems that it presents to the initiation and operation of discriminatory programs. It has previously been suggested that discriminatory programs could be formulated with sufficient flexibility for market-wide application for all dealers or as a competitive technique for an Individual dealer within the market. In this respect some persons contacted expressed concern that individual dealers would have a tendency to use discriminatory programs as a means of gaining new customers from competitors. For example, suppose a dealer has a customer who has been given a base of sixty quarts of regular milk per month and an 249 allowane® of fifteen quarts of surplus milk. It is possible for © competitor* to approach that same customer and offer him a base of 45 quarts per month and an allowsnce of 15 quarts of surplus milk at a discounted price* If the dealer could win this pai^tlcular customer on this basis, it would represent new business for the dealer* For the market, however, it would mean the loss of the sale of a quart of milk at the regular price and no additional sale of milk at the discounted price* If companies could pursue these activities, it is readily seen that chaotic market conditions would soon follow. To prevent this type of activity it is proposed that a customer must be served by a dealer for a given period (assume three months or more) prior to the inauguration of the discriminatory program* During this period of time the dealer would collect sufficient information to establish a base for the family. Other dealers would not possess sufficient information to establish a base for the family. In the event that the customer decided to switch from one dealer to another, the family would lose its right to participate in any discriminatory program. All the milk sold to the customer by the new dealer would be considered as regular fluid milk. The dealer would not be given an allowance of discounted surplus milk for such 250 familles* Through such a procedure the dealers In the market could not use the differential between fluid and manufaoturing milk prices as an incentive to obtain new customers. Any price concessions that a dealer wanted to make to obtain new customers from other dealers would not consist of those involving surplus milk during the period of discrimination. The limitation placed upon dealers in establishing bases for individual customers has the effect of partially freezing families to certain dairies. A customer would be forced to stay with a certain dealer or milkman for the period of discrimination or forfeit the right of participating in a surplus milk program* Of course, the customer would have perfect freedom to change routemen or dealers, if he were dissatisfied with the service, or quality of milk received from a particular dealer. However, if the consumer did change, he would be expected to pay the regular price for all milk purchased. Theoretically, it would be possible for one dealer to transfer information concerning a particular customer's base and surplus allotments to another dealer. This transfer could be accomplished in much the same way that base quotas are sometimes transferred for producers in the event that a producer decides to ship to another 251 dealer in the market. From a practical point of view tills transference of information would seem to be an un­ necessary complication to the operation of discriminatory programs. In most markets the number of customers trans­ ferring from one dealer to another during a six-month period is not apt to be very large* As long as the discriminatory program cannot be used as a means for on® dealer to gain another dealer's customers, the problem of some families' changing of routexaen during the period of discrimination does not appear to be serious enough to warrant special provisions for this possibility* Problems pertaining to the administration and account­ ing required for discriminatory programs would be considerable in all markets. Most of these problems would be the responsi­ bility of the dealer* This study admits that even in markets which might present the most favorable environment for discriminatory programs, the administrative aspects required for any workable program would place many added burdens upon the dealers. It is possible that the dealers could shift some of the administrative and accounting work to the routemen. However, it would still be the responsibility of the dealer to supervise and coordinate these activities. One of the first administrative problems that would arise as a part of discriminatory programs for fluid milk 25S Is the establishment of bases for individual families reoelvlng delivered milk as outlined in Chapter VIII. It may be decided in the market, or by a dealer, that the program should be restricted to those families which had uniform quantities of milk delivered per purchase. Limiting surplus milk to only those families who have regular delivered purchase patterns would reduce adminis­ trative problems to a minimum. However, it may be that acceptable bases can be established for many consumers by relaxing this requirement somewhat. Setting bases for these families would require considerable adminis­ trative effort on the part of both routeman and dealers. It is assumed that the dealer or the routeman would have to give some individual consideration to all the families that purchased delivered milk. However, it is also assumed that only a portion of the eligible families would participate in discriminatory programs. After these families were known, additional administrative effort would be centered only around these customers who might be handled without adding additional clerical help or equipment. It would seem advisable to shift as many of the administrative problems as possible to the routeman and supervise and check his activities. The routeman has contact with the customer and if he were familiar with ©IX th@ detail© pertaining to hi® customer*® base end surplus ellotmente many problems and mlaunderst&ndings iMOuia be avoided. Dealer# would be responsible for maintaining accurate records of surplus milk for accounting purpose# all the way from the producer to the consumer, have the same accounting procedure. No two dealers One dealer's system of records may be such that this additional administrative load could be handled without too much difficulty. Other dealers may require an entirely new accounting routine which would be unwelcome as a prerequisite to discrimi­ natory programs. In a very ideal situation administrative activity would be a serious limitation, Where it is apparent that administrative requirements are excessive» it is suggested th&t consideration be given to alternative programs that could minimise administrative problems and still achieve the objective of discrimin&tion, Such programs could be centered around coupons and/or other dairy products such as chocolate milk and fluid cream, A very important practical problem at the dealer level arises in program# of price uiscrimin&tlon for fluid milk because of the heterogeneous nature of dealers ' marginal cost curves, No two dealers have exactly the same fixed or variable costs. Some dealers may have made very large investments in plant and equipment in order to reduce 264 labor to a ©ialumi* Other dealers may have fouiid it advisable to substitute labor for capital expendi­ tures for their size of opération. It is readily seen that the component parts of the variable and fixed costs in these circumstances are entirely different. For example, one dealer reported a plant processing variable cost of less than one cent per quart. This figure included all the variable costs involved, from receiving the milk to placing it in the truck of the routeman for an additional quart of milk above the plant's present volume. This particular dairy had large investment in capital equipment and a high volume of business. A smaller dairy replacing mechanized operations by hand labor could very easilÿ have a plant processing variable cost two or three times greater than that of a large efficient plant. The difference In the cost structure for individual dealers within one market is an important limitation to price discriminatory programs that are based upon marginal cost principles. The differential in price between base and surplus milk at the consumer level should be sub­ stantial in order to make discriminatory programs feasible. The difference in marginal cost for various dealers operating under heterogeneous cost structures end capacities may make marginal cost pricing techniques 266 advisable for some and prohibitive for other dealers* Price discrimination for some individual dealers in these circumstances could be a veiy powerful competitive weapon. It is possible that in some markets where oligopoly tenden­ cies are great, individual dealers would reject programs of price discrimination on these grounds. The difference in cost structures for individual firms and the unfavorable reaction that might be caused by various dealers attempting to adjust their businesses to discriminatory techniques might preclude any favorable consideration by dealers of discriminatory programs. At best, market-wide application of discriminatory programs would have to be designed to cover the marginal cost for surplus milk for all dealers to assure full acceptance* Otherwise some dealers may find a flat price reduction of a small amount more favorable than a sizable marginal price reduction which could well lead to cut-throat competition and chaotic market conditions. In some markets it may be possible that the various dealers would have similar cost structures so that marginal cost practices would have a somewhat uniform effect through­ out the market* It would seem that in these circumstances prices could be established in the market both for regular and surplus milk which would be acceptable for establishing a stable market for discriminatory practices. £56 The various way® In which difiereat dealers make use of their surplus fluid milk may raise some insurmountable problems to market-wide discriminatory programs, Borne dealers are prepared to make much more efficient and better use of surplus milk than are other dealers. For example, dome markets may permit dealers to us© surplus milk at manufacturIng milk prices for making ice cream. The price of surplus fluid milk for making butter may be the same as that for making ice cream. It is readily seen that milk going into ice cream for some dealers may command a much higher return from the consumer then that going into butter# la other words* those dealers who have good alternative uses for excess Grade à milk may find it more profitable to use their excess milk in this way rather than to attempt to divert it to discriminatory programs designed to increase the consumption of fluid milk. The only way that these dealers would find it advantageous to participate in discriminatory programs would be to have more than sufficient excess fluid milk to meet all higher alternative uses so that some would be still available for lower uses such as making butter, With every dealer in the market having some Grade A milk going into butter, the Incentive for participating in discriminatory programs would be somewhere equal for 257 ©11 dealers. It is common practice in fluid milk markets for dealers to transfer surplus Grade A milk between each other. In the event that some dealers had a shortage of surplus Class 1 milk that could be used in a discriminatory program, it is possible that interdealer transfers could meet the obstacles of this problem without involving any different activity than is usually found in the market. So far this study has avoided the legal implications of market-wide discriminatory programs. In the event that discriminatory pricing became a market-wide activity, it has been assumed that most dealers would establish the same prices for a two-price system of discrimination. It is supposed that these prices would be established in a manner similar to the way that the regular price for fluid milk is established In most markets. Dealer agreements in setting retail prices are illegal under the anti-trust laws. Be that as it may, most dealers in a particular market establish the same price for a homogeneous grade of milk whether it be through competitive forces, oligopoly tendencies or other types of understanalog or activity. It may be that establishing a uniform price for discounted surplus milk on such a basis as that for regular 258 milk would require collusion and agreement of some type that would be illegal* legal aspect© of price discrimi­ nation have been avoided in the light of the objective of this study. If it can be shown that breaches in anti­ trust laws would be involved in discriminatory programs, it seems that it could readily be shown that the same activity is Involved in the procedure of retail price maintenance for fluid milk in the face of increased seasonal production. Although market-wide participation in a discriminatory program by all dealers implies and requires at least some Implicit agreement and understanding, nevertheless, the results of such activity may come closer to meeting the standards of a competitive market than a policy of holding the price. If it can be shown that some consumers would be better off and none worse off under discriminatory programs than they are under the present policy of retail price maintenance, then legal arguments against discrimination are considerably weakened. It should be borne in mind that in some markets, state milk marketing orders not only sat the prices to producers but they also establish prices at the retail level* In the case of rellef-milk cited earlier in 259 this Chapter, the Secretary of Agriculture was empowered to establish dealer margins on most relief-milk. Federal marketing orders are, in effect, legalized breaches of anti*trust laws in that all dealers are required to pay to the producers at least a specified minimum price for the milk that is used for various purposes# Marketing agreements covering fruits such as oranges, nuts and some vegetables could be considered in the same category. Federal or state legislation could pave the way for price discrimination programs for milk. If anti-trust limitations were the primary obstacle to the inauguration and operation of discriminatory programs for fluid milk, it would seem that an adequate rationale would exist for overcoming this objection. At best, the federal government’s program of price supports is a contradiction of the intent of anti-trust legislation. In view of the large accumulation of butter that the government is purchasing at great expense to the tax­ payers because of parity commitments, price discriminatory programs for fluid milk should be encouraged because they are designed to help prevent Grade A milk from reaching the form of butter. In fact, if supporting the price of butter through open market activities is a legitimate expenditure of public funds, then many arguments exist 260 for using public funds to subsidize disci'ljainatory programs for fluid milk* It seems reasonable to assume that price supports for butter at high levels might adversely affect the differential between fluid and manufacturing milk which is the underlying Justification for seasonal programs of price discrimination for fluid milk* Only a few of the most obvious problems that face the dealers in discriminatory programs have been mentioned. It is r eadily seen that In some markets they may be pro­ hibitive obstacles to the inauguration and operation of discriminatory programs * In all probability the dealer would be the central figure in any discriminatory program. It is assumed that dealers are interested in promoting the consumption of fluid milk. As an individual organi­ zation they may pursue this end by competing for their competitor's business while protecting their own sales. However, it would appear that as a group, a general increase in consumption of fluid milk would not only benefit them but the consumer as well* As in the case of producers, discriminatory programs as outlined la this study are designed to yield, in the main, indirect benefits to dealers* It seems certain that discriminatory programs for fluid milk would have very little chance for success if dealers were not willing to participate 261 on a marginal cost basis, plus a fair margin for profit, In order to increase the differential between regular and surplus milk* It would seem that dealer cooperation in a discriminatory program would be evidence that they were doing those tiling© at their disposal to encourage the consumption and sale of fluid milk. l-hf.....Sole. of the Deliveryman Discriminatory programs as considered by this study have been centered around delivered milk. This arrange­ ment means that the routemen can do much to promote or hinder discriminatory programs. It would be the routemen who would come in direct contact with the consumer. In order for the routemen to be able to promote and defend discriminatory programs they must be convinced of the program's value to the consumer as well as to themselves. Interviews with various persons revealed mixed feelings concerning the willingness of routemen to co­ operate in discriminatory programs. An official foi* one company where the routemen were organized under a labor union felt that it would be difficult to obtain the cooperation of routemen in delivering surplus milk at a reduced margin, à labor union official and routeman, however, indicated that he felt routemen would be perfectly 262 willing to participât© in a discriminatory program if it would increase milk consumption and provided it did not adversely affect milk sales at the regular price. It is obvious that in some markets present union regulations and de&ler-routemen pay-plans would preclude the Initiation of discriminatory practices. In any market discriminatory programs would present new problems involving routemen. However, if discriminatory programs were successful in increasing milk consumption, routemen would have some direct incentive for participating in such programs which may he sufficient to overcome the problems involved. One routem&n expressed the feeling that price consider­ ations would not be an incentive for consumers to purchase more milk* but suggested advertising campaigns involving educational activities directed at stressing health would be more effective in Increasing milk consumption than any type of price reduction. This person felt that consumers might respond to programs Involving chocolate milk or whipping cream. The sales manager from this company felt that the price elasticity of demand among consumers was not as inelastic as the routeman had indicated. Be that as it may* if all routemen felt as this one* discriminatory programs would have little chance for success without changing some of the routemen*s values, even though 263 coasuffi©x*s would endorse and support base and surplus plans as a means of increasing fluid milk consumption. The margin covering the cost of delivering milk in most markets is substantial* It has been assumed that this margin can be reduced considerably for surplus fluid milk sold under discriminatory programs. This reduction would mean that the routeman would receive a smaller margin for delivering a quart of surplus milk than he would receive for delivering a quart of regular milk. In all probability pay-plane between dealers and routemen would have to be adjusted somewhat to reflect the desired margin on surplus milk. If the routemen were normally paid on a flat commission basis, it may be that the commission rate could apply to price-discounted milk also. For example, assume that regular milk were selling for 20 cents per quart and that the routemen were allowed a commission of 25 percent on sales for delivering the milk. Under this assumption, it would mean that the routeman would receive five cents per quart for delivering regular milk. How suppose the discounted milk was to be sold at 12 cents per quart. If the commission rate were still 25 percent on price discounted surplus milk, the routeman*s commission would amount to three cents per quart. In this circumstance £64 feii® routeman'® margin is reduced two cents per quart without changing the usual commission rate. In most markets price discriminatory programs would require that routemen be paid on a separate basis for the milk sold at the regular price from that sold at the discounted price* The division between base and surplus sales for each family would allow the adjustment of routemen*® margins to a wide variety of pay plans. If routemen were normally paid a small commission and a guaranteed base salary, then a separate commission rate could apply to surplus milk if it were deemed necessary. It may be desirable to guarantee a minimum fixed margin to routemen for handling surplus milk. Through this means the routemen would know that they were getting some direct remuneration for each additional quart of surplus milk sold even though it was considerably below the usual margin. If a routeman had 50 customers that were taking an extra quart of surplus milk per delivery and his margin was fixed at three cents per quart, he could readily see that he was adding $1.50 to his pay check for delivering the surplus milk. He may also realise that it might be easier to add this #1.50 by handling surplus milk at a reduced margin, rather than 265 have to sell so quarts of milk at the regular price so h® could, realize the same amount of added income, when his usual margin was five cents per quart* It would seem that most dealer-routemen pay plans could be adjusted for discriminatory programs if cooperation was forthcoming from the routemen* One retail salesmanager expressed concern about the possibility of routemen being able to sell discounted milk at the regular price and thus obtain the extra margin for themselves. At this company routemen were charged specific prices for the various items that were loaded in their trucks and they could sell them as they saw fit within certain limitations, No check was made by the dealer of the routebooks to ascertain the prices and quantities of the various items going to each customer* This dealer indicated that surplus milk could be labelled with a special cap indicating the price of the milk and designating its purpose as a means of avoiding misuse of surplus milk by routemen* In addition to this procedure it seems that it would still be wise to spot check routebooks to verify the base and surplus allocations for individual customers. Problems are also presented at the routeman level because of various methods of paying for milk by the customer* Some individuals pay daily, others weeicly, etc# 866 In these circumstances, problems arise concerning the division between base and. surplus milk for so short a period* It was pointed out that the problem may be handled by rebates for surplus milk to the customer at the end of the month. Some disadvantage is attached to this procedure, however, since extra accounting is involved and price incentives may lose some of their value. Another problem is presented to routemen because of the prevalence of vacations during the suaaaer months. Base and surplus allotments would have to taic® these considerations into account. If the family were away half of the month the base should be reduced accordingly. Again such problems would largely fall to the xouteiaen. One routeman indicated that some resentment may arise on the part of the customer when discriminatory programs were terminated on a seasonal basis. He felt that consumers would feel that if the dealers could sell milk under a discriminatory program for six months that they could do it on a year around basis. Consumers would complain to routemen about such things even though the routemen had little or no influence over discriminatory programs as a whole. It is possible that programs using coupons or stamps could minimize this difficulty as well as some of the other problems listed above. 867 Th© full coopération of routemen is essential in aigr program of discrimination involving delivered milk. If the consumer responds to such programs, It seems readily apparent that much is to be gained by the routemen. On the other hand, the response of the customer may be largely determined by the efforts of the routemen. It may be the task, of the dealer to break this vicious circle through promotional techniques before discriminatory programs would be successful, lM tiflt.M rJ!£Q gr.am ....oll.m .sc.riM m t_lD ii It is obvious from this and the preceding chapter that many practical problems must be answered b@fox*@ undertaking discriminatory programs, The paramount issue is still the response of the consumer. If consumers would accept and support discriminatory programs, then much can be clone to solve many of the practical problems. If consumers refuse to participate in discriminatory programs then these problems cease to exist. It is, of course, granted that many of the problems are directly interwoven with consumer acceptance of discriminatory pricing. these reasons it is suggested that initial or pilot programs be designed for markets that may present the most favorable environment for discrimination. Small For 268 market® where the details of the program can be initiated and tested on a trial basis would seem to be suited for exploratory purposes. It is impossible to visualize many of the impacts or ramifications from such programs without experiencing actual operation. It must be admitted that the nature of fluid milk markets precludes extensive generalizations from one market to another. However, those characteristics that markets have in common make it possible to use some judgment and comparisons in determining the advisability of certain marketing practices and techniques* These inter-market relationships also make it possible to use common ground for finding solutions to many problems. CHAPTEH X SUMMARY M D CONCLUSIONS The hypothesis of this study has teen that the per capita consumption of fluid milk can be increased in some markets through pricing and promotional programs involving price discrimination at the consumer level w M c h would be acceptable to consumers, dealers, and producers. The following conditions have been assumed as given: 1, Individual peculiar problems and practices in each market. 2, Consumption of fluid milk is fairly uniform from month to month, 3, Production of Grade A milk experiences seasonal variation* considerably more milk being produced in late spring and summer months than in the fall and winter months. 4, An aggregated market demand for fluid milk with a price elasticity of demand that is inelastic for prices and quantities usually encountered in the market. 5, Borne elements of monopoly in each market. 6, Pricing policies that involve retail price maintenance during periods of increased seasonal production. 270 This study contends that within the general market structure as postulated above, possibilities exist for using programs of intra-consumer price discrimination as a means for increasing milk consumption in some markets* Buch programs would Involve using a two-price system in the sale of fluid milk to Individual consumers who could participate in the program on a voluntary basis. The study has been centered primarily around those families that have most of their milk delivered- It is proposed that a modified base and surplus plan be established for these families * The base for the consumer would consist of an allotment of milk on a monthly or periodic basis that would correspond to probable purchases for the period as revealed by past records of purchases. This milk would be priced at the regular price prevailing in the market. Participating consumers would be given the opportunity of purchasing additional surplus mille above the base allotment at a reduced price. In other words, a family might be allotted a base of 45 quarts per month which would be sold at the regular price. An additional allowance of surplus milk which would be sold at a reduced price could be allocated to the same family. Those families who felt participating in such a program was worth while could do so on a voluntary basis. Families 271 who were not Interested in additional price-discounted milk would pay the regular price for all their purchases* Intra-consumer price discriminatory programs would thus attempt to select from the market those families who show some response to price variations. Families who might not be responsive to price change would not receive direct benefit from the program. The selection or segregation of consumers according to price response Involves inter-consumer discrimination, since different families In the same market would be purchasing the same product under different pricing policies. Programs involving discriminatory pricing would be used to supple­ ment the general policy of retail price maintenanceibr the market, rather than serving as an altexmtive pricing policy. It is a contention of this study that the price differential between fluid and manufacturing milk can be used as an incentive to encourage some consumers to increase their fluid milk consumption through programs of intra-consumer price discrimination. Instead of diverting excess Grade A milk into the manufacture of So-called lower-use products, it is proposed that the dealer be allowed to use this milk for bottling purposes at manufacturing milk prices. This excess Grade A milk 272 for mauuTaoturijtig milk purposes is largely a result of seasonal increases In production* Therefore, it is proposed that programs of price discrimination he designed on a seasonal basis to correspond to fluctuations in production so that the price differential between fluid and Manufacturing milk can be used as an incentive for consumers to increase milk consumption when increased production occurs. In addition to the price differential between fluid and m&nufacturing milk, other economies are possible under some situations* These can be used to lower the price of surplus milk to the consumer and thus to encourage additional consumption. Marketing margins can be reduced for the milk sold to consumers as price-discounted surplus milk. In other words, efficiencies that can be gained in the use of labor and equipment for handling this additional volume of milk can be used to lower the dealer's marginal cost. If an attempt be made by the dealer to cover only marginal cost plus a reasonable allowance for profit for this additional milk, further reductions in the price for surplus milk can be achieved which could be passed on to the consumer as an added incentive for some consumers to increase milk consumption. As long as the marginal return was greater than the marginal cost for handling 273 tiiis surplus milk, the dealer and the industry would have ©a inoentive to participate in programs of price discrimination. fh© focal point of Intra-eonsuiser price discrimination is the response of the consumer to such programs. Unfortu­ nately, no empirical data is available to use as a possible guide In predicting the consumer's reaction to discrimi­ natory techniques involving the sale of milk. The hypothesis of this study was tested by resorting primarily to economic theory. As an aid in obtaining a conceptual framework for some of the probable consumer reactions, recourse was made to partial equilibrium analysis and the tools of microstatic economics. M analysis of consumer's demand under the assumptions of static economics and diminishing marginal rates of sub­ stitution revealed that consumer price-quantity responses are more inelastic for a given price reduction under policies involving intra-consumer price discrimination than they are under uniform or flat pricing policies. This result indicates that consumers would always purchase less milk for © given price reduction under discriminatory pricing than they would under a uniform or flat price reduction. In other words, consumers would purchase more milk if the price were reduced two cents per quart on all quantities purchased, than they would if the two cent reduction applied only to the additional quantities purchased. 274 Under actual market conditions uniform or flat price reduetions seldom, If ever, amount to more than two cents per quart. Adjustments In price in most markets usually consist of one cent per quart* The analysis shows that a sizable (five to ten cent) reduction on a discriminatory basis would be much more effective in increasing consumption than a small (one or two cent) reduction under uniform pricing for most oonsumers. Under a properly executed program of price discrimination increased consumption represents an addition to total revenue which means extra profit to the dairy industry, if marginal revenue is greater than marginal cost fox* the additional milk sold. Thex*efore, it may be profitable in some markets for the dairy industry to use the price differential between fluid and manufacturing milk plus economies due to more efficient use of equipment and labor as a means of increasing the consumption of fluid milk through programs of price discrimination. An examination was made of consumer's welfare with the aid of Indifference curve analysis under the assumption of diminishing marginal rates of substitution. Comparisons were made concerning the consumer's welfare under the following three alternative pricing policies that might be pursued in the market during periods of increased seasonal milk production: (1) Retail price maintenance. 275 (B ) a uniform or flat price reduction, (3) iatra*consumer discrimination or a two price system of discrimination. It was found for a given flat price reduction or a given differential of the same amount for a two-price system of discrimination, the consumer was better off under policies involving uniform price reductions. Either a policy of uniform price reduction or a two-price system of discrimination was more desirable for the consumer than a policy of retail price maintenance. In a two-price system of discrimination, a comparatively large reduction in price for surplus milk was found to be preferable to the consumer than a small reduction in price on a uniform or flat price basis for all milk purchased. In the situation where the consumer's price elasticity of demand was elastic, it was found that the consumer could always be as well off under some patterns of price discrimination as under any flat price reduction* In the event that the consumer's price elasticity of demand was inelastic, the analysis revealed that generally flat price reductions were much more effective in increasing the consumer's satisfaction then patterns of pricing involving a two-price system of discrimination. The more inelastic the consumer's demand for fluid milk, the greater would the price reduction on a discriminatory basis need to 276 b© to compensate for a given price reduction on a uniform or flat price basis in order to leave the consumer at the same level of satisfaction. If all consumers in the market had a price elasticity of demand that was inelastic, a flat price reduction during periods of increased seasonal production would never be granted to the consumer, if it were assumed that the dairy industry would exercise its monopoly powers. However, even in the ease where consumer's price elasticity of demand is relatively inelastic it may be profitable for the dairy industry to grant price reductions on a dis­ criminatory basis as a means of increasing the sale of fluid milk# The consumer would always be as well, or better off, in these circumstances than under a policy of retail price maintenance. The ease for price discrimination as a means of increasing fluid milk consumption is strengthened where the marginal utility of money is constant for the consumer's purchases of fluid milk. As long as there is some sub­ stitution effect between milk and money, a given price reduction on a discriminatory basis is as effective in increasing consumption of fluid milk as a flat price reduction under this assumption. 877 Xn the event that the price elasticity of demand for consumer is perfectly inelastic, then neither e flat price reduction nor a price reduction on a discriminatory basis would be effective as a means of increasing fluid milk consumption* It seems vex*y reasonable to assume that this condition might he descriptive of the demand for fluid milk for many individual consumers, for all prices and quantities that might be feasible for flat or discrimi­ natory price reductions. However, it is possible that the price elasticity of demand for some consumers is perfectly inelastic for a small range of prices and quanti­ ties and would exhibit some degree of elasticity either above or below this range. Empirical studies show that the price elasticity of demand for fluid milk is always greater than perfectly inelastic. An elasticity of .30 is often considered descriptive of many markets at prices and quantities usually encountered. Although this figure indicates that the aggregate price elasticity of demand is relative­ ly inelastic, it may also indicate that the elasticity for some consumers is relatively elastic when it is assumed that some persons show no response in quantities of milk purchased to change in price. 276 It is a conclusion of this study that the probable heterogeneous nature of individual consumer demand makes programs of intra-consumer discrimination desirable for increasing milk consumption in some markets. Such programs could be designed to attempt to appeal to those who exhibit some response to changes in price for fluid milk without affecting those who do not. In other words, through discrimination, the objective would be to improve the well-being of some without changing that of others. The probable nature of most Individual consumer demand functions makes it necessary to increase the price differential between regular and price-discounted milk as much as possible in order for discriminatory practices to be effective as a means of increasing fluid milk con­ sumption. Cooperative effort on the part of producers, dealers, routemen and other persons concerned with the marketing of fluid milk is required to bring about the objectives of price discrimination as outlined by this study, Although achieving this cooperative effort is a serious limitation to the proposed programs, it is the contention of this study that mutual benefit and gain exists as &n incentive for overcoming the problems involved. 879 Administrative problems pertaining to the inauguration and operation of dlseriMlaatory programs for fluid, milk constitute a serious limitation of such programs. Using surplus milk in discriminatory programs involves additional accounting and clerical activity affecting consumers, dealers, routemen, producers, sad perhaps others, who might be concerned with the marketing of milk. Adminis­ trative techniques must be designed to minimize the sub­ stitution or resale of surplus for regular milk by individual families, or between families, if discriminatory programs are to be effective in increasing fluid milk consumption. This limitation suggests that delivery purchases are best suited for the control and restrictions that must be placed on consumers to minimize substitution and resale activities. Although discriminatory programs may be possible for milk purchased at the store which would involve a minimum of administrative effort, it is doubtful that they would be as effective in increasing the consumption of fluid milk m programs centered around delivered purchases. The results of this study have shown that it may be possible to use other dairy products such as chocolate milk and fluid cream in discriminatory programs designed to increase the consumption of milk. Administrative problems resulting from the us© of these products can 880 be considerably less than for programs using surplus fluid Milk# Substitution and resale activities which would influence unfavorably the sale of regular fluid milk would be minimized by the use of these products in discriminatory programs. the use of coupons or stamps redeemable in prizes or merchandise has some advantages over monetary discounts as a means of increasing milk consumption in discriminatory programs. It is possible that people who would not partici­ pate in a program involving price discounted milk would be inclined to make additional purchases of milk or dairy products to obtain coupons which were redeemable for merchandise. Administrative effort may be considerably reduced by using coupons. Coupons also offer the advantage that consumption of milk may be increased without altering the retail price since price fluctuations are looked upon with much misgiving by many people associated with the dairy industry. The theoretical framework as developed by this study is suggestive rather than definitive. It has been the purpose of this study to develop a conceptual framework that might be used to analyze some of the actual problems that would be encountered in inaugurating and operating discriminatory programs designed to increase the consumption 281 Bilk. The analytical models that have been used to form the compoaent parts of the general framework have been stripped of many of their refinements, consistent with the need for adjusting them to the particular problems that they were designed to clarify. Many weaknesses and limitations in connection with the usefulness and applica­ bility of this study to actual practice exist, both as a result of unrealistic or invalid assumptions as well as of errors end lack of ability to perceive and handle the problems that might be involved, general. this study has been very It is hoped that applications can be made to specific situations. From these applications evidence would be forthcoming to prove or disprove empirically the validity of the general theoretical contentions. It is a conclusion of this study that an environment exists in some markets which is favorable enough to justify attempts to lucrease the consumption of fluid milk through discriminatory programs, It is a recommendation of this study that initial attempts at discriminatory programs be confined to small markets or on a small scale in larger markets that might present the most favorable environment as suggested by the theoretical framework of this study, gxperienae gained from such pilot pi-ograms could be used as a guide for making whatever adjustments might be required to formulate workable programs for these pilot markets as well as for other markets. BIBLIOGRAPHY Anonymous, "An Analysis of the Spread Between Farm and Gonsumer Milk jPrices In Hew York City Under Present Practices," Report of the Hew York State Temporary Cmmission on Agriculture^ Part I, 1948-49. 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