Price discrimination and product differentiation leads to more efficient markets. Many contemporary discussions of economics begin by addressing the issue of the so-called Pareto efficiency or optimality. Vilfredo Federicao Damaso Pareto was an Italian intellectual during the later part of the 19th century and early part of the 20th century. A Pareto optimal distribution of a bundle of goods is one where all parties agree that the allocation cannot be improved upon without hurting at least one other party. It does not mean that everyone is happy with the distribution; it just means you cannot improve on the distribution without creating a disadvantage for one of the groups or parties. I like to use the word Pareto OK rather than Pareto optimal. A Pareto OK distribution of goods takes into account the idea the distribution of goods is equitable and the welfare of all is optimal given a distribution of incomes and consumer wants. A Pareto OK distribution is also more in tune with Pareto’s original conceptualization of optimality and welfare economics. The so-called Paretian welfare economics is built on three principles: 1
- Each individual is to be treated as the final judge of his or her welfare.
- The welfare of society depends on the welfare of the individuals who make up the society.
- If one person’s welfare increases, other things being equal, then societal welfare increases.
These three principles can be distilled into a single maxim: “as far as social choice is concerned, all that matters is the satisfaction of wants” (Robert Sugden, p. 507).
One goal of developing multiple products and using a product and price differentiation strategy is to deliver products that satisfy wants. Economists are always worried about economic efficiency and societal welfare. The natural questions related to price differentiation is whether this leads to efficient markets and whether society is better off. I propose the following definition of market efficiency:
A market tends to be efficient when the market participants have complete knowledge about the prices and features of products and services offered in the market.
This definition is somewhat different than the traditional definition because it incorporates the idea that market participants are knowledgeable about prices and that they are also knowledgeable about the features of a product. Efficient markets emerge when information is freely available. Dynamic and adaptive markets emerge when there are a variety of products and services available and market participants have the tools available to gather information on the products and services. Search engines and auctions are extremely effective tools for gathering information and developing knowledge about pricing and features and that is why the Internet has been such a powerful force for facilitating efficient markets.