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You could be paying higher insurance premiums than someone with the same driving history, car and background because of price optimization

Summary:
See Your habits may be costing you by Kayda Norman of Nerdwallet.The price optimization the article mentions sounds like what economists call "price discrimination." That is explained below. In the article, it sounds like the unwillingness to shop around means that your demand is less elastic and those customers get charged a higher price.Excerpts from the article:  "some insurers jack up prices based on seemingly unrelated data — like your magazine subscriptions or what groceries you buy.Even if you have a clean driving record and have stayed loyal to your insurance company for the past 10 years, you could be paying higher premiums than someone with the same driving history, car and background. Why? Price optimization.Price optimization is the practice of charging higher rates based

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See Your habits may be costing you by Kayda Norman of Nerdwallet.

The price optimization the article mentions sounds like what economists call "price discrimination." That is explained below. In the article, it sounds like the unwillingness to shop around means that your demand is less elastic and those customers get charged a higher price.

Excerpts from the article: 

"some insurers jack up prices based on seemingly unrelated data — like your magazine subscriptions or what groceries you buy.

Even if you have a clean driving record and have stayed loyal to your insurance company for the past 10 years, you could be paying higher premiums than someone with the same driving history, car and background. Why? Price optimization.

Price optimization is the practice of charging higher rates based on the likelihood that a person will not shop around for a lower price. Insurers create algorithms based on all kinds of personal data, including loyalty to other service providers and shopping behavior, but not your driving habits. This is a separate formula from other common auto insurance rate factors like age, neighborhood, gender and the type of car you drive.

Factors can run the gamut from your magazine subscriptions, the number of phones you buy and your web browsing history. This means a company's most loyal customers may be most affected by this practice."

"Price optimization is illegal in 20 states"

"Because companies use different algorithms to determine rates, price optimization can affect anyone who doesn't compare insurance rates often."

"The reason they can charge you $1,000 and another person $2,000 is because the person paying $2,000 doesn't know about the $1,000 company out there"


Charging different prices to different groups of customers based on their ability and willingness to pay (a discount) is price discrimination.

Why price discrimination raises profits

1. If a firm can get a higher price from some customers than others they increase their profits.
2. If a firm can lower the price for others who might not have bought the product to begin with, they also increase their profits.

Necessary Conditions for Price Discrimination

1. The firm must face a downward sloping demand. Monopolies do but firms in perfect competition do not (their demand, also their MR line, is flat).

2. The firm must be able to readily (and cheaply) identify buyers or groups of buyers with predictably different elasticities of demand (senior citizens have a more elastic demand and will shop around more since they have more time so restaurants might give them a discount). The more elastic the demand, the greater the change in quantity demanded for a given change in price.

3. The firm must be able to prevent resale of the product or service. If a student can buy a movie ticket for $6 while everyone else pays $8, the firm will lose money if the students turn around and sell their tickets for $7. So the theater can prevent resale by checking student IDs to make sure people holding the lower price ticket really are students.

#2 might be the key here for Amazon. The lower income customers will be spending a bigger share of their budgets on Amazon products and services. One of the determinants of elasticity is how much of your budget you spend on the item. As this goes up, your demand becomes more elastic (that is, quantity will change more for a given change in price). You are affected alot more by a change in the price of cars than a change in the price of donuts. So if the price of cars doubles, the quantity demanded will fall much more than if the price of donuts doubles.

And when firms can price discriminate, as explained above, they will charge lower prices (offer discounts) to those groups with higher elasticities. The number of substitute goods and the amount of time consumes have to adjust to price changes also affect elasticity.

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