The market for spectacles in West Germany: Price discrimination and taxation by regulation

Hess, Hans-Wilhelm (1986) The market for spectacles in West Germany: Price discrimination and taxation by regulation. PhD thesis, University of Glasgow.

Abstract

This thesis explains several economic phenomena in the market for spectacles which have lone confounded interested observers. Such phenomena include: 1. Prices of spectacles are almost completely uniform over the whole of West - Germany. 2. At the same time the industry is preponderately small scale. Economic theory would normally explain such pricing and industry structure either with perfect competition or in terms of a high degree of cartelization. The existence of perfect competition is ruled out for the market of spectacles and a high degree of cartelization is not normally associated with low concentration ratios and small-scale enterprises. Thus, one is lead to suspect a high degree of regulation in this health sector of the economy. As the likelihood of market failure through externalities, asymmetry of information and natural monopoly is explored it becomes obvious, however, that regulation as severe as to cause the observed pricing behaviour is not called for. The theory of taxation by regulation, developed by Richard Posner in 1971, offers an explanation. According to this theory it is often in the interest of regulators to make the regulated industry supply certain commodities or services at regulated prices below cost and subsidize these by charging above cost for commodities which are not regulated. In the case of spectacles such cross-subsidisation may take the form of price discrimination. However, aspects of price discrimination between differentiated commodities, although discussed in spatial economics, are strangely neglected by the traditional theory of price discrimination and the view is widely held that only third degree price discrimination exists in practice. Recent developments in the theory of price discrimination are presented which acknowledge that product differention may play a role and that second degree price discrimination may exist in practice. Spectacles can be seen as differentiated commodities using the Lancastrian characteristics approach. They are then viewed as bundles of characteristics, i.e. they are made up of the characteristic correction of faulty vision which they all have in common bundled with additional characteristics such as prestige through better quality frames, comfort through lightweight lenses etc. An empirical investigation reveals that a high degree of product differentiation does indeed exist in the market for spectacles and that the complex situation can only be adequately explained if the distinction between horizontal and vertical product differentiation is introduced. Posner's theory is verified empirically if it can be shown that the prices of the different varieties of the differentiated commodity spectacles are discriminatory such that the basic commodities provided at regulated prices are sold below cost and other varieties above cost. Normally, the "hedonic" method is used to test empirically for price discrimination. By defining demand-based and cost-based variables a hedonic demand and a cost schedule are obtained by multiple regression. Price differences which are due to demand influences are then taken as proof of price discrimination. In this vein a hedonic demand and a cost schedule are estimated and the existence of price discrimination in the market for spectacles is seemingly established. However, a discussion of the method reveals severe shortcomings: 1. The hedonic method does not incorporate the distinction between horizontal and vertical product differentiation. Therefore the complex pricing structure cannot be adequately described. 2. The hedonic method produces unambiguous estimates of costs of differentiated commodities only if pure competition is assumed. However, in the context of price discrimination pure competition is ruled out by definition. It is therefore necessary to develop and use a model of price discrimination which takes horizontal and vertical product differentiation into account and to employ a method of cost estimation which is valid in a monopolistic environment. The model developed in this thesis employs the Lancastrian concept of characteristics space and combines vertical and horizontal product differentiation with second and third degree price discrimination to show costs and prices in three dimensions. Prices and costs are measured on the y-axis, quantities of the differentiated varieties on the x- and z-axes. Such a three-dimensional representation produces price- and cost-planes showing exactly which varieties are sold below cost, which cover cost and which are sold above cost. As already mentioned, an unambiguous estimation of costs is essential. The relevant cost concept is that of marginal cost under full adaptation. Calculation of marginal cost is greatly facilitated if it can be shown that marginal cost is constant, for then, marginal cost equals average cost. It is shown that marginal cost is constant by constructing a long-run average cost curve and a Cobb-Douglas production function from data which the association of opticians in West Germany has collected. The costs of each individual differentiated commodity are made up of average cost and separate cost. Average and separate cost of each individual variety of spectacles were estimated in a cost study undertaken in the writer's own optical practice in Germany by methods of conventional cost accounting according to advice given by the chief cost accountant of the Volkswagen factory at Kassel. Costs of every pair of spectacles are thus determined and compared to the prices of each individual variety. It is therefore possible to construct the price- and cost-planes for a representative sample. These exhibit almost exactly the magnitude and shape that was predicted by the theoretical considerations. Thus, the empirical work confirms the theoretically derived predictions that: 1. The pricing structure of the optical profession in Germany is highly discriminatory. 2. Provision of "National Health" spectacles is cross-subsidized by revenues from spectacles sold at unregulated prices.

• Item Type: Thesis (PhD)
• Qualification Level: Doctoral
• Keywords: Economic theory, Commerce-Business
• Date of Award: 1986
• Depositing User: Enlighten Team
• Unique ID: glathesis:1986-76709
• Copyright: Copyright of this thesis is held by the author.
• Date Deposited: 19 Dec 2019 09:15
• Last Modified: 19 Dec 2019 09:15
• URI: https://theses.gla.ac.uk/id/eprint/76709