8 Market Power and Price Discrimination

The number of new cars and light truck sales of U.S. automakers in 2022, according to statista.com was over 13.5 million units.  Most new car sales take place in automotive dealerships.  Automotive dealerships are independent franchise businesses that generally have market protection thanks to state governments.  Dealerships are affiliated with an automaker but can generally charge whatever sales price they want.  Dealerships are the middleman.   Dealerships are given specific sales territory, have local employees,  and are spread out throughout an individual state giving them outsized political power.  Some argue that consumers would encounter lower prices if they were able to purchase a vehicle directly from the manufacture cutting out the “middleman”.  Other’s argue auto dealerships provide an extra layer of protection for a consumer durable good that is highly regulated during its production (ex. Safety) and its use (ex license).  State laws protecting auto franchise rights could be argued to protect consumers from the market power of multibillion auto companies and ensure warranty, safety, and quality of purchases.  What ever argument you favor, there is no denying that automotive dealerships franchise rights provide some market power that allows them to price discriminate in the market place.  The Manufactures Suggested Retail Price (MSRP) is exactly that, suggested.  Shop for a new car from multiple dealerships affiliated with the same manufacture and you are likely to encounter different prices.  Commission sales people have price flexibility.   Negotiation over price has been the cultural norm in auto sales.  It can be a challenging process to negotiate the price of a new car.  Studies have shown average price differentials with different groups paying different prices.  Studies have shown people of color, older people, women and those that traded a used car on average are charged higher prices.  (Rosalsky 2022).  Some dealerships are instead using a fixed price non-negotiable sales price displayed on the car to minimize the purchase hassle for consumers.  However, the feedback is mixed as there is concern that consumers end up paying higher prices due to their inability to negotiate.    There is still price discrimination using the fixed price model as dealership sales people try to extract consumer surplus through add on sales such as rust proofing, convenience packages, and added warranties.  The key for consumers to get the best price on a new car is to widen the area you are willing to shop, have flexibility in the type of vehicle you desire, and be patient in negotiation.

1. Define the difference between 1st, 2nd and 3rd degree price discrimination.
2. What type of price discrimination have dealerships traditionally used to determine sales price? Explain your reasoning.
3. How have auto dealerships in the past been successful in price discrimination? Why has it worked?  Is the internet changing the ability of companies to successfully price discriminate?
4. How are car salespeople and ticket scalpers similar in their use of price discrimination? Explain your reasoning.
5. Tesla’s distribution model strategy involves directly selling vehicles to consumers. Although they do not have franchise dealerships in most states due to legal restrictions, how does Tesla pricing practices discriminate.

References:

Rosalsky, Greg (2022) Inside the rise of ‘stealerships’ and the shady economics of car buying. National Public Radio. https://www.opb.org/article/2022/09/04/inside-the-rise-of-stealerships-and-shady-economics-of-car-buying/

Why Dealer Franchise Laws? Why states promote the buying and selling of cars through local dealerships.  https://www.nada.org/media/3267?id=21474838847