DOCSLIB.ORG

Reservation Price As a Range: an Incentive- Compatible Measurement Approach

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Reservation Price As a Range: an Incentive- Compatible Measurement Approach TUO WANG, R. VENKATESH, and RABIKAR CHATTERJEE* Drawing from the literature on buyers’ uncertainty in preference and product knowledge, the authors suggest and empirically test the proposition that a consumer’s reservation price for a product is more meaningfully and accurately represented as a range than as a single point. Given this conceptualization, they propose an approach for incentive-compatible elicitation of a consumer’s reservation price range (ICERANGE) that builds on Becker, DeGroot, and Marschak’s (1964) point-of-purchase method. Two empirical applications of the approach provide an assessment of its practicality and its predictive performance relative to current methodologies for reservation price elicitation. The results demonstrate that the proposed method significantly outperforms the benchmark approaches in terms of predictive validity and yields valuable incremental information about uncertainty in product valuation. Reservation Price as a Range: An Incentive- Compatible Measurement Approach Reservation price is a well-known and widely invoked customization and personalized pricing in several industries economic concept (Varian 1992). In common parlance, a (Choudhary et al. 2005), motivating accurate individual- consumer’s reservation price represents the maximum price level reservation price measurement. Second, marketing he or she is willing to pay for one unit of a good or service. researchers are applying recent methodological advances in Value pricing, product design, negotiations, and bundling areas such as experimental economics and Bayesian statis- are some substantive areas that depend on understanding tics to the measurement of reservation prices. Third, there is the reservation prices of individual consumers. a lack of consensus on the “right” way to measure (and, we Although the concept of reservation price has appeared in contend, even define) a consumer’s reservation price that the economics literature for well over a century (e.g., Dav- has left open avenues for further research. These factors, enport 1902), there is growing interest in advancing the especially the third, provide the motivation for our study. understanding and measurement of the construct, particu- For illustration, consider the following definitions of larly in marketing (Chung and Rao 2003; Jedidi, Jagpal, reservation price (italics added): and Manchanda 2003; Jedidi and Zhang 2002; Wertenbroch •“The minimum price at which [a consumer] would no longer and Skiera 2002). We attribute this interest to three factors. purchase the [product]” (Hauser and Urban 1986, p. 449). First, the advent of e-commerce has paved the way for mass •“The price at which a consumer is indifferent between buying and not buying the product” (Moorthy, Ratchford, and Taluk- dar 1997, p. 265). *Tuo Wang is Assistant Professor of Marketing, College of Business •“The price at or below which a consumer will demand one unit Administration, Kent State University (e-mail: [email protected]). R. of the good” (Varian 1992, p. 152). Venkatesh is Associate Professor of Business Administration (e-mail: [email protected]), and Rabikar Chatterjee is Professor of Business These three definitions differ from one another in the sense Administration (e-mail: [email protected]), Joseph M. Katz Graduate that in each case, the reservation price maps onto a different School of Business, University of Pittsburgh. The authors thank the late propensity to buy on the part of the consumer. They con- Dick Wittink and Russ Winer, the four anonymous JMR reviewers, Eileen verge only if the consumer’s propensity to buy transitions Bridges, Pradeep Chintagunta, Esther Gal-Or, John Hulland, Jeff Inman, Vijay Mahajan, Vikas Mittal, Vanitha Swaminathan, and doctoral students from a definite yes to a definite no at a single price point in Marketing at the Katz School for their helpful comments. They appreci- rather than over a range of values. ate the programming support from Leela Venkatesh and the help with data We propose that it is more reasonable to conceptualize a collection from Karen Page. The research has been funded by a grant from consumer’s reservation price as a range, with each of the the Katz Center for Industrial Competitiveness and two research grants definitions representing specific supports within the range. from the Office of the Dean at the Katz School. As we discuss in the next section, the literature on con- To read and contribute to reader and author dialogue on JMR, visit sumers’ preference uncertainty (e.g., Fischer, Luce, and Jia http://www.marketingpower.com/jmrblog. 2000) and performance/quality uncertainty (e.g., Rust et al. 1999) lends theoretical support to this proposition. If a con- © 2007, American Marketing Association Journal of Marketing Research ISSN: 0022-2437 (print), 1547-7193 (electronic) 200 Vol. XLIV (May 2007), 200–213 Reservation Price as a Range 201 sumer’s reservation price for a particular product is a range indirect measure of utility (Hauser and Urban 1986) or “a tied to the probability of purchase rather than a point, the direct monetary measure of product value” (Kalish and Nel- seller’s best price for the consumer depends on this range son 1991, p. 327). and its mapping onto purchase probability. In other words, One commonality among the three definitions of reserva- ignoring the range in an individual consumer’s reservation tion price cited in the preceding section is that they link, at price when it exists is likely to lead to problems, such as least implicitly, the definition to the consumer’s probability suboptimal pricing. of purchase at a particular price point. The difference lies in The primary contribution of our study is methodological. the implied purchase probability: 0% in Urban and Hauser’s We propose an approach called ICERANGE, which is short (1986) definition, 50% in Moorthy, Ratchford, and Taluk- for incentive-compatible elicitation of the range in a con- dar’s (1997), and 100% in Varian’s (1992). The lack of con- sumer’s reservation prices. Our approach, which is tied to sensus goes beyond these three studies.1 actual choice and is motivated by Becker, DeGroot, and In our conceptualization, a consumer’s reservation price Marschak’s (1964; hereinafter BDM) point-of-purchase is explicitly tied to his or her probability of purchasing the methodology, is the first in the literature to measure con- good. On the basis of the implied probability of purchase in sumers’ reservation prices as a range. The range measure- current definitions, we identify the following three signifi- ment is significant because the theory of uncertainty and cant reservation price points: related literature in experimental economics (and other 1. Floor reservation price is the maximum price at or below areas) underscore the notion that the point representation of which a consumer will definitely buy one unit of the product reservation price is tenuous. The range characterization (i.e., 100% purchase probability). retains the point measure as a special case. We demonstrate 2. Indifference reservation price is the maximum price at which that ICERANGE performs better than multiple benchmarks a consumer is indifferent between buying and not buying in two studies in which participants (college students) had (i.e., 50% purchase probability). the opportunity to buy the product (Belgian chocolate in 3. Ceiling reservation price is the minimum price at or above one study and Australian wine in the other). The two studies which a consumer will definitely not buy the product (i.e., confirm the existence of the reservation price range. Fur- 0% purchase probability). thermore, data from the more elaborate chocolate study Our motivation for the range representation comes from support our premise that consumers’ reservation price the uncertainty literature and related work in experimental ranges are positively related to their respective levels of economics (e.g., Ariely, Loewenstein, and Prelec 2003), performance- and preference-related uncertainty. Although resource economics (e.g., Gregory, Lichtenstein, and Slovic the elicitation procedure for ICERANGE is somewhat more 1993), psychology (e.g., Jacowitz and Kahneman 1995), involved than that for BDM, we address possible related and marketing (e.g., Urbany, Dickson, and Wilkie 1989). concerns. This range conceptualization seems able to unify the vari- We elaborate on the conceptual and theoretical underpin- ous definitions of reservation price (as a range of thresh- nings of our range characterization in the next section. olds). We note that utility theory has axiomatically treated Then, we compare and contrast alternative routes to reser- reservation price as a single-point measure, under the vation price measurement and draw from this discussion to assumption that participants know their preference struc- propose ICERANGE. In the two subsequent sections, we tures with certainty (thus, there may be uncertainty related describe the applications in the chocolate and wine cate- to product performance but not to preference structure). Our gories. Our concluding section outlines the scope and impli- conceptualization allows for both sources of uncertainty. cations of ICERANGE, as well as the study’s limitations Next, we examine the theoretical bases for this and future research directions. conceptualization. CONCEPTUALIZING RESERVATION PRICE AS A Theoretical Underpinnings for Reservation Price as a RANGE Range We first review the alternative definitions of reservation The single-point representation
Load more

Recommended publications
  • The Willingness to Pay, Accept, and Retire∗
    The Willingness to Pay, Accept, and Retire∗ Philipp Schreiber,y Christoph Merkle,z Martin Weberx January 2016 Abstract Today's pay-as-you-go social security systems are put under pressure by increasing life ex- pectancy, the baby boomer generation entering retirement, and an early effective retirement age. In developed countries, many employees retire before reaching the full retirement age. Conduct- ing a large online experiment, we relate the retirement timing decision to the disparity between the willingness-to-accept (WTA) and the willingness-to-pay (WTP). Our results reveal that the framing of the decision problem strongly influences the reservation price for early retirement. The willingness-to-accept for early retirement is more than twice as high as the corresponding willingness-to-pay. Using actual values from the German social security system as market prices, we show that the presentation in a WTA frame can induce early retirement. In this frame, the implicit probability of retiring early increases by 30 percentage points. We also show that the disparity between WTA and WTP is correlated with loss aversion. Repeating the analysis in a representative household survey (German SAVE panel) we find similar results. JEL-Classification Codes: D03, D14, H55, J26 Keywords: Retirement Timing, Willigness-to-pay, Willigness-to-accept, Social Security. ∗We are grateful to the Frankfurter Allgemeine Zeitung for conducting the study with us. Intensive discussion with two journalists, Anne-Christin Sievers and Patrick Bernau, helped to considerably improve the questionnaire. We would also like to thank Sven Nolte for helpful comments. We further thank seminar participants at the University of Mannheim, participants of the IMEBESS 2014, Oxford, the Whitebox Advisors Graduate Student Conference 2014, Yale, the EF Conference 2014, Zuerich, and the German Finance Association 2014, Karlsruhe for valuable suggestions.
    [Show full text]
  • MICROECONOMICS and POLICY ANALYSIS - U8213 Professor Rajeev H
    MICROECONOMICS AND POLICY ANALYSIS - U8213 Professor Rajeev H. Dehejia Class Notes - Spring 2001 Auctions Wednesday, February 14 Reading: Handout, Thaler, Milgram There are two basic forms of auctions: Sealed bid submissions and open bids. In a sealed bid auction individuals do not know what others are bidding. Two types of Sealed Bid Auctions: 1st Price sealed bid auction: The highest bid submitted will be the winning bid. The winner pays what he/she bid. 2nd Price sealed bid auction: Everyone submits sealed bids and the winner is the one who submits the highest bid BUT the price paid by the winner is the 2nd highest bid submitted. Two types of open auctions: English auction: The bidding starts low and incrementally rises until someone is the highest bidder and no one is willing to outbid the highest bidder. Dutch auction: The price starts very high and is keeps going down until someone bids. The first person to bid wins. Why Study Auctions? 1) Auctions can be an efficient method of valuing goods. For example: rights to air waves, signals and bandwidth. The government auctioned off parts of the spectrum in anticipation of new technology. The auctions were appealing because well- structured auctions get people to reveal the true valuation of the good. The company (private entity) actually ends up paying to the government what the good is worth to them. It turned out with these auctions that the willingness to pay for a slice of the spectrum, as revealed by the auction outcome, was much higher than expected. 2) Procurement: Governments and entities want to procure goods and services at the lowest possible price (like an auction in reverse).
    [Show full text]
  • Testing Neoclassical Competitive Market Theory in the Field
    Testing neoclassical competitive market theory in the field John A. List* Agricultural and Resource Economics, University of Maryland, 2200 Symons Hall, College Park, MD 20742-5535 Communicated by Marc Nerlove, University of Maryland, College Park, MD, October 4, 2002 (received for review July 25, 2002) This study presents results from a pilot field experiment that tests terminates. One major difference between my experimental predictions of competitive market theory. A major advantage of design and Chamberlain’s design is that I allow for learning, this particular field experimental design is that my laboratory is the because subjects interact in multiple market periods. A more marketplace: subjects are engaged in buying, selling, and trading fundamental difference, of course, is that I am observing the activities whether I run an exchange experiment or am a passive behavior of agents who have endogenously chosen certain roles observer. In this sense, I am gathering data in a natural environ- within the market [such as being a buyer (nondealer) or seller ment while still maintaining the necessary control to execute a (dealer), intense or casual market participant, etc.]. A further clean comparison between treatments. The main results of the important characteristic of my field experiment is that I organize study fall into two categories. First, the competitive model predicts the four market treatments in a manner that allows me to explore reasonably well in some market treatments: the expected price and the role of buyer and seller experience on market outcomes: quantity levels are approximated in many market rounds. Second, treatment one includes randomly chosen buyers and randomly the data suggest that market composition is important: buyer and chosen sellers; a second treatment matches super-experienced seller experience levels impact not only the distribution of rents buyers with relatively inexperienced sellers; a third treatment but also the overall level of rents captured.
    [Show full text]
  • Experiments, and the Classical Theory of Price Formation Vernon L
    Neoclassical Supply and Demand, Experiments, and the Classical Theory of Price Formation Vernon L. Smith Chapman University (based on joint work with Sabiou M. Inoua) CUNY Department of Economics November 3, 2020 Orientation: Classical economic representation of agents (buyers and sellers) in markets: Commodity space is discrete; transactions involve single units. (Think of a shopping basket with 1 qt. milk, # bacon, jar olives, box of cereal…our model allows but does not require multiple units.) Buyers each value a unit of a good, measured by the maximum amount of money they are willingness to pay for it. In aggregate, think of buyers defined by a distribution function values, v = d (Q); sellers each have minimum willingness to accept c = s (Q); d is non-increasing (order property of a DF); similarly s (Q) is non- decreasing. Price is not in these DFs because P has not yet been found by “higgling and bargaining” in the market. WHAT THIS TALK IS ABOUT *Role of experiments in discovering the failure of the neoclassical MU paradigm to predict experimental outcomes. *Revisiting classical value theory, i.e., the price formation discovery process as viewed by classical economists. *Formalizing the content of classical value theory PART I: DISCOVERING THE FAILURES OF NEOCLASSICAL MU ECONOMICS VIA EXPERIMENTS Characteristics of early market experiments • Small numbers • Each subject assigned one unit (or a few) • DA (oral outcry) trading rules (exogenous to economics) • Private decentralized value/cost information • Zero public information • Subjects Naïve in Economics • Prices unexpectedly converged to approximate a S&D clearing price, a point or set of points pre-defined in the experiments.
    [Show full text]
  • A Probabilistic Approach to Pricing a Bundle of Products Or Services Author(S): R
    A Probabilistic Approach to Pricing a Bundle of Products or Services Author(s): R. Venkatesh and Vijay Mahajan Reviewed work(s): Source: Journal of Marketing Research, Vol. 30, No. 4 (Nov., 1993), pp. 494-508 Published by: American Marketing Association Stable URL: http://www.jstor.org/stable/3172693 . Accessed: 07/11/2011 11:11 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact [email protected]. American Marketing Association is collaborating with JSTOR to digitize, preserve and extend access to Journal of Marketing Research. http://www.jstor.org R. VENKATESHand VIJAYMAHAJAN* The authors propose a probabilistic approach to optimally price a bundle of products or services that maximizes seller's profits. Their focus is on situations in which consumer decision making is on the basis of multiple criteria. For model de- velopment and empirical investigation they consider a season ticket bundle for a series of entertainment performances such as sports games and music/dance con- certs. In this case, they assume consumer purchase decisions to be a function of two independent resource dimensions, namely, available time to attend performances and reservation price per performance. Using this information, the model suggests the optimal prices of the bundle and/or components (individual performances), and corresponding maximum profits under three alternative strategies: (a) pure com- ponents (each performance is priced and offered separately), (b) pure bundling (the performances are priced and offered only as a bundle), and (c) mixed bundling (both the bundle and the individual performances are priced and offered sepa- rately).
    [Show full text]
  • The Optimal Reservation Value with Market Movements
    The optimal reservation value with market movements Yunyi Zhang School of Management, Huazhong University of Science and Technology, Wuhan 430074, China [email protected] Pu Gong School of Management, Huazhong Univeristy of Science and Technology, Wuhan 430074, China [email protected] Abstraction Despite the topic of real estate liquidity has aroused wide attention and research, the relationship between reservation values and liquidity is still little known in terms of theory. This paper investigates the problem that a seller of a house considers auction as the main form of sale mechanism to price its reservation value based on the market conditions, the demand changes and the likelihood of successful sale. We measure market value movements and market liquidity, deriving the seller’s optimal price. Our results show that seller’s reservation value moves more slowly than bidders not only in the upward market but also in the downward market. Meanwhile, market liquidity is greater in the upward market than in the downward market. In addition, the influencing factors that seller’s reservation value changes with market also include the inherent value of house and the number of participants arrived. Keywords: pricing, an auction process, market movement INTRODUCTION The real estate market is an important one that receives much concern from industry and academia while liquidity is a key topic of real estate research. Comparing with a public market, liquidity in a private asset market is less. Hot real estate market exhibits a rising trend with greater trading volume and higher price than norm, and it is much easy to sell assets (greater liquidity).
    [Show full text]
  • Chapter 3: Supply and Demand • Market
    Chapter 3: Supply and Demand • Market- the market for any good consists of all buyers and sellers of that good • Demand curve- a schedule or graph showing the quantity of a good that buyers wish to buy at each price; marginal benefit curve • Substitution effect- the change in the quantity demanded of a good that results because buyers switch to or from substitutes when the price of the good changes • Income effect- the change in the quantity demanded of a good that results because a change in the price of a good changes the buyer’s purchasing power • Buyer’s reservation price- the largest dollar amount the buyer would be willing to pay for a good • Supply curve- a graph or schedule showing the quantity of a good that sellers wish to sell at each price; marginal cost curve • Seller’s reservation price- the smallest dollar amount for which a seller would be willing to sell an additional unit, generally equal to marginal cost • Equilibrium- a balanced or unchanging situation in which all forces at work within a system are cancelled by others • Equilibrium price and equilibrium quantity- the price and quantity at the intersection of the supply and demand curves for the good • Market equilibrium- occurs in a market when all buyers and sellers are satisfied with their respective quantities at the market price • Excess supply- the amount by which quantity supplied exceeds quantity demanded when the price of a good exceeds the equilibrium price • Excess demand- the amount by which quantity demanded exceeds quantity supplied when the price of
    [Show full text]
  • PAGE ONE Economics the Back Story on Front Page Economics CLASSROOM EDITION
    PAGE ONE Economics the back story on front page economics CLASSROOM EDITION The Rising Cost of College: Tuition, Financial Aid, and Price Discrimination January 2014 An informative and accessible economic essay with a classroom application. Includes the full version of the Page One Economics Newsletter , plus questions for students and an answer key for classroom use. Common Core Standards (see page 11) Scott A. Wolla Economic Education Group of the Federal Reserve Bank of St. Louis © 2014, Federal Reserve Bank of St. Louis. www.stlouisfed.org/education Permission is granted to reprint or photocopy this lesson in its entirety for educational purposes, so long as this copyright notice is included on all copies. PAGE ONE Economics the back story on front page economics NEWSLETTER January I 2014 The Rising Cost of College: Tuition, Financial Aid, and Price Discrimination Scott A. Wolla, Senior Economic Education Specialist “The fact is, college has never been more necessary, but it’s also never been more expensive.” —President Barack Obama, August 22, 20131 The cost of college tuition has been in the headlines frequently in recent years. Conventional wisdom says the cost of a college education is rising—but is it really? The “sticker price” for a college education has risen three times faster than the inflation rate since 1978. However, when we adjust for inflation, expressing the cost in terms of constant dollars, and account for finan- cial aid (which reduces the overall cost), average tuition and fees have remained effectively unchanged.
    [Show full text]
  • Microeconomics (Pricing with Market Power, Ch 11)
    Microeconomics (Pricing with market power, Ch 11) Microeconomics (Pricing with market power, Ch 11) Lecture 16-17 Mar 09 & 16, 2017 Microeconomics (Pricing with market power, Ch 11) 11.2 PRICE DISCRIMINATION First-Degree Price Discrimination Perfect Price Discrimination The additional profit from producing and selling an incremental unit is now the difference between demand and marginal cost. Imperfect Price Discrimination Figure 11.3 First-Degree Price Discrimination in Practice Firms usually don’t know the reservation price of every consumer, but sometimes reservation prices can be roughly identified. Here, six different prices are charged. The firm earns higher profits, but some consumers may also benefit. With a single price P*4, there are fewer consumers. The consumers who now pay P5 or P6 enjoy a surplus. Microeconomics (Pricing with market power, Ch 11) 11.2 PRICE DISCRIMINATION Second-Degree Price Discrimination ● second-degree price discrimination Practice of charging different prices per unit for different quantities of the same good or service. ● block pricing Practice of charging different prices for different quantities or “blocks” of a good. Figure 11.4 Second-Degree Price Discrimination Different prices are charged for different quantities, or “blocks,” of the same good. Here, there are three blocks, with corresponding prices P1, P2, and P3. There are also economies of scale, and average and marginal costs are declining. Second- degree price discrimination can then make consumers better off by expanding output and lowering cost. Microeconomics (Pricing with market power, Ch 11) 11.2 PRICE DISCRIMINATION Third-Degree Price Discrimination ● third-degree price discrimination Practice of dividing consumers into two or more groups with separate demand curves and charging different prices to each group.
    [Show full text]
  • Global Economics (Fall 2013) “How a Market System Functions”
    ECON 1100 – Global Economics (Fall 2013) “How a Market System Functions” Relevant Readings from the Required Textbooks: Economics – Chapter 4, Demand, Supply, and Market Equilibrium Economics – Coda, “I, Pencil” Problems from the “Economics” Textbook: Chapter 4 Problems (Pages 70-71): 4, 8, 9, 12, and 14 Definitions and Concepts: money – an asset that is socially and legally accepted as a medium of exchange. three functions of money: . medium of exchange – an asset used as payment when purchasing goods/services . store of value – an asset that serves as a means of holding wealth . unit of measure – a basic measure of economic activity demand – the relationship between the price of a good and the quantity that consumers are willing and able to purchase, all other factors fixed supply – the relationship between the price of a good and the quantity that firms are willing and able to sell, all other factors fixed Law of Demand – all other factors fixed, a greater quantity of a good will be demanded at lower prices (demand curves are downward sloping). Law of Supply – all other factors fixed, a greater quantity of a good will be supplied at higher prices (supply curves are upward sloping). “Horizontal Interpretation” of Demand Curve – start by focusing on a particular price, and then go over to the demand curve horizontally to determine the corresponding quantity demanded at this particular price. “Vertical Interpretation” of Demand Curve – start by focusing on a particular quantity demanded, and then go up to the demand curve vertically to determine the corresponding price at which this particular quantity would be demanded.
    [Show full text]
  • Markets and Welfare Economics
    MARKETS AND WELFARE ECONOMICS The global economy is, in part, the collection of markets for the goods and services, financial assets, and foreign currency traded between people and firms from different countries. In order to understand the global economy we must first have a rudimentary understanding of how markets work. Since all the students in the class have had at least one previous course in economics, this topic should be a review of what they/you already know. I encourage you to review your notes and books about this topic. In this handout I will only provide a brief outline of the topics we will develop more fully in class. Market – an arrangement between buyers and sellers in order to exchange Behavior of Buyers - Demand Demand – relationship between amount buyers willing to buy at all possible prices, holding all else constant. Law of demand Demand Curve Change in price brings about a change in quantity demanded, not demand. Determinants of demand - bring about changes in demand. Income, price of related goods, etc. Increase and decrease in demand – Shift right or left Behavior of Sellers - Supply Supply – relationship between amount sellers willing to sell at all possible prices, holding all else constant. Law of Supply Supply Curve Change in price brings about a change in quantity supplied, not supply. Chapter 4 - page 2 Determinants of supply - bring about changes in supply. Costs, technology, etc. Increase and decrease in supply – Shift right or left Market - interaction between buyers and sellers Bring Demand and Supply curves together Role of Price Shortages Surpluses Equilibrium Price Market Equilibrium Changes in determinants of supply or demand shift supply and demand curves bringing about a new equilibrium Changes in market equilibrium Further examination of markets – Welfare Economics Welfare Economics Demand, of course, reflects the behavior of consumers and supply reflects the behavior of producers.
    [Show full text]
  • Supply and Demand PRINCIPLES of ECONOMICS (ECON 210) BEN VAN KAMMEN, PHD Introduction the Next 2 Chapters Contain the Most Important Model Economics Has to Offer
    Supply and Demand PRINCIPLES OF ECONOMICS (ECON 210) BEN VAN KAMMEN, PHD Introduction The next 2 chapters contain the most important model economics has to offer. It is a model of the market for a good and how its price and output are determined. It maintains many of the insights (trade, productivity, preferences, terms of trade) gleaned from the preceding chapter but also requires a bit more exposition. The model’s assumptions •With respect to any particular good, the economy is divided into two groups: buyers and sellers. • Also sometimes called “consumers/producers” or “demanders/suppliers”. •There is a good that serves as a unit of account to measure buyers’ and sellers’ values and the prices of other goods. •This also serves as the medium of exchange, thus avoiding the necessity of double coincidence of wants. • I.e., buyers buy things with money (denoted $). • Money is just a special example of a numeraire good chosen to express the prices of other goods. Buyers and sellers assumptions •Each buyer has a willingness to pay, • i.e., the maximum they are willing to give up to buy this good. •Sellers each have a reservation price, • i.e., the minimum they insist on receiving in exchange for this good. •Buyers and sellers can be ranked according to willingness to pay and reservation price, respectively. Eliciting the willingness to pay The demand curve With buyers ranked from highest willingness to pay to lowest, for any price, you can count how many buyers value the good at least as much as the price. This is the quantity demanded at that price.
    [Show full text]