Customer Demand: Foundations
1.1. Willingness to pay
1.1.1. Introduction to Demand
Let's start our exploration of "demand" by looking at Ace Ticket's challenge. Ticket reselling (or ticket
brokerage, as it's also referred to) is a useful business to look at for many reasons. It's a simple product
to understand. It's easy to relate to—many of you have probably bought tickets on the secondary
market at some point. And it allows us to see some simple economics in action.
Jim Holzman, Ace Ticket's CEO, compares ticket brokerage to stock brokerage:
We face the same pressure that a stockbroker has in the middle of an exchange. That market is open
seven or eight hours a day. My market is open 24 hours a day, 7 days a week. The only difference is that
every single ticket I sell has a value going to zero as the event approaches. Once the event has started,
I'm pretty much done. That's the pressure that's on us.
Ticket brokerage might seem like a relatively easy business to manage. It's not. There are certain parts
that are relatively straightforward indeed. As Holzman described, figuring out the supply of tickets is not
particularly complicated since there is a limited supply of seats in a stadium. However, getting a handle
on demand is another story.
What price should Ace set for its tickets? How should it vary prices for different seats? And how should
it vary prices over time? Ace Ticket's pricing problem is more complicated than for most businesses,
since it's setting prices not just for one seat, but for hundreds of seats, and it's changing prices
frequently, sometimes even hourly. In comparison, pricing decisions in many other settings are made
far less frequently and for fewer products. But exploring Ace Ticket's problem can help shed light on
many ideas in the "economics of demand." So, we'll use ticket brokerage as a setting to introduce some
important concepts in economics that are useful in many other settings and you'll be on your way to
learning some real economics.
1.1.2. The Price is Right?
It’s often tempting to look at product prices and jump immediately to a conclusion of whether they’re
“too high” or “too low.” Ticket prices greater than $1,000 for a single game appear outrageously high if
you think about what else a customer could do with that money. For example, she could buy a new
premium refrigerator, a 50” high-definition LCD television, or round-trip plane tickets to Florida. On the
other hand, the prices might be considered too low if, for example, you believe that Boston fans are
sports-crazy (which they are) or if the demand for the product far exceeds its supply (which it did for
this game).
All these arguments appear reasonable. However, by themselves, they don’t tell managers much about
the answer to the question of whether their prices are “too high” or “too low.” If, for example, nearly
all customers consider $1000+ prices for a single game to be outrageous, then Ace would be pricing
too high. If, on the other hand, enough fans viewed these tickets as a once-in-a-lifetime opportunity
for which they’d pay far more, then Ace could be leaving a lot of money on the table.
The key point is that for firms to know whether they’re making pricing decisions correctly, they need a
benchmark against which to evaluate prices. It would be very useful to first know how much customers
,are willing to pay for their product. Prices, by themselves, tell you almost nothing about the answer to
the question of whether they’re right or not.
The idea that we need benchmarks against which to evaluate economic decisions is a very general one,
and it's an idea that we’ll see over and over again. For example, we might observe a company's profits,
but that alone doesn't tell us how well the company is doing. We'd want to know what kinds of profits
other companies in its industry earn. Profits, like prices, are merely outcomes that we observe in a
market. In order to understand whether these outcomes are sensible or not, we first need to better
understand the primitives of the problem; in this case, what customers are willing to pay for tickets in
the first place.
We'll return to the distinction between market outcomes and primitives later, in other contexts. But
first, let’s explore further the idea of customer willingness to pay.
1.1.3. Willingness to pay
Let’s say you had a chance to buy a ticket to an event. It could be a football game. It could be the
national figure skating championships. Or it could be a music concert.
Ace Ticket has offered tickets for all these types of events. Indeed, the problem of “figuring out
demand” that Holzman described is far more general, it turns out, than just pricing football games.
Let’s explore the customers' willingness to pay for events like these. First of all, we'll consider the game
we started with—the New England Patriots versus the Baltimore Ravens in the AFC Championship.
Someone’s got an extra ticket and is giving you the first chance to buy it. You can only make one offer
and if it’s not accepted, the ticket goes to someone else.
How much would you be willing to pay for a ticket to this game? What would your top price be?
Note: Please enter your answer as a whole number without decimals.
,As another example, let’s consider a concert—Taylor Swift is coming to town. (For those of you who
don’t know, Taylor Swift is a country music star, one of the most popular performers of the last decade,
who’s sold more than 75 million digital single downloads, making her one of the best-selling artists in
history.)
Swift’s concert in Boston was sold out within hours of tickets going on sale. But of course, tickets were
available in the resale or secondary market. And that’s where you find yourself.
Again, someone’s got an extra ticket and is giving you the first chance to buy it. You can only make one
offer and if it’s not accepted the ticket goes to someone else.
How much would you be willing to pay for a ticket to attend the Taylor Swift concert? What would your
top price be?
, The number you just keyed in is a very important one in economics. It’s what we call the “willingness
to pay” (which we’ll sometimes denote for short as “WTP”). It’s the maximum price you are willing to
pay for a product or service. Of course, you’d be glad to pay less than your “willingness to pay” if you
could, but the important thing is that you wouldn’t pay more than it.
1.1.4. WTP and Price
• In many countries, primary education is provided for free. This means that in these countries
consumers’ WTP for primary education is zero; otherwise, a private market for education would
have developed.
• Suppose that normally your WTP for a cashmere sweater is $100. What would your WTP for
a cashmere sweater be if they marked it 50% off?
1.1. Willingness to pay
1.1.1. Introduction to Demand
Let's start our exploration of "demand" by looking at Ace Ticket's challenge. Ticket reselling (or ticket
brokerage, as it's also referred to) is a useful business to look at for many reasons. It's a simple product
to understand. It's easy to relate to—many of you have probably bought tickets on the secondary
market at some point. And it allows us to see some simple economics in action.
Jim Holzman, Ace Ticket's CEO, compares ticket brokerage to stock brokerage:
We face the same pressure that a stockbroker has in the middle of an exchange. That market is open
seven or eight hours a day. My market is open 24 hours a day, 7 days a week. The only difference is that
every single ticket I sell has a value going to zero as the event approaches. Once the event has started,
I'm pretty much done. That's the pressure that's on us.
Ticket brokerage might seem like a relatively easy business to manage. It's not. There are certain parts
that are relatively straightforward indeed. As Holzman described, figuring out the supply of tickets is not
particularly complicated since there is a limited supply of seats in a stadium. However, getting a handle
on demand is another story.
What price should Ace set for its tickets? How should it vary prices for different seats? And how should
it vary prices over time? Ace Ticket's pricing problem is more complicated than for most businesses,
since it's setting prices not just for one seat, but for hundreds of seats, and it's changing prices
frequently, sometimes even hourly. In comparison, pricing decisions in many other settings are made
far less frequently and for fewer products. But exploring Ace Ticket's problem can help shed light on
many ideas in the "economics of demand." So, we'll use ticket brokerage as a setting to introduce some
important concepts in economics that are useful in many other settings and you'll be on your way to
learning some real economics.
1.1.2. The Price is Right?
It’s often tempting to look at product prices and jump immediately to a conclusion of whether they’re
“too high” or “too low.” Ticket prices greater than $1,000 for a single game appear outrageously high if
you think about what else a customer could do with that money. For example, she could buy a new
premium refrigerator, a 50” high-definition LCD television, or round-trip plane tickets to Florida. On the
other hand, the prices might be considered too low if, for example, you believe that Boston fans are
sports-crazy (which they are) or if the demand for the product far exceeds its supply (which it did for
this game).
All these arguments appear reasonable. However, by themselves, they don’t tell managers much about
the answer to the question of whether their prices are “too high” or “too low.” If, for example, nearly
all customers consider $1000+ prices for a single game to be outrageous, then Ace would be pricing
too high. If, on the other hand, enough fans viewed these tickets as a once-in-a-lifetime opportunity
for which they’d pay far more, then Ace could be leaving a lot of money on the table.
The key point is that for firms to know whether they’re making pricing decisions correctly, they need a
benchmark against which to evaluate prices. It would be very useful to first know how much customers
,are willing to pay for their product. Prices, by themselves, tell you almost nothing about the answer to
the question of whether they’re right or not.
The idea that we need benchmarks against which to evaluate economic decisions is a very general one,
and it's an idea that we’ll see over and over again. For example, we might observe a company's profits,
but that alone doesn't tell us how well the company is doing. We'd want to know what kinds of profits
other companies in its industry earn. Profits, like prices, are merely outcomes that we observe in a
market. In order to understand whether these outcomes are sensible or not, we first need to better
understand the primitives of the problem; in this case, what customers are willing to pay for tickets in
the first place.
We'll return to the distinction between market outcomes and primitives later, in other contexts. But
first, let’s explore further the idea of customer willingness to pay.
1.1.3. Willingness to pay
Let’s say you had a chance to buy a ticket to an event. It could be a football game. It could be the
national figure skating championships. Or it could be a music concert.
Ace Ticket has offered tickets for all these types of events. Indeed, the problem of “figuring out
demand” that Holzman described is far more general, it turns out, than just pricing football games.
Let’s explore the customers' willingness to pay for events like these. First of all, we'll consider the game
we started with—the New England Patriots versus the Baltimore Ravens in the AFC Championship.
Someone’s got an extra ticket and is giving you the first chance to buy it. You can only make one offer
and if it’s not accepted, the ticket goes to someone else.
How much would you be willing to pay for a ticket to this game? What would your top price be?
Note: Please enter your answer as a whole number without decimals.
,As another example, let’s consider a concert—Taylor Swift is coming to town. (For those of you who
don’t know, Taylor Swift is a country music star, one of the most popular performers of the last decade,
who’s sold more than 75 million digital single downloads, making her one of the best-selling artists in
history.)
Swift’s concert in Boston was sold out within hours of tickets going on sale. But of course, tickets were
available in the resale or secondary market. And that’s where you find yourself.
Again, someone’s got an extra ticket and is giving you the first chance to buy it. You can only make one
offer and if it’s not accepted the ticket goes to someone else.
How much would you be willing to pay for a ticket to attend the Taylor Swift concert? What would your
top price be?
, The number you just keyed in is a very important one in economics. It’s what we call the “willingness
to pay” (which we’ll sometimes denote for short as “WTP”). It’s the maximum price you are willing to
pay for a product or service. Of course, you’d be glad to pay less than your “willingness to pay” if you
could, but the important thing is that you wouldn’t pay more than it.
1.1.4. WTP and Price
• In many countries, primary education is provided for free. This means that in these countries
consumers’ WTP for primary education is zero; otherwise, a private market for education would
have developed.
• Suppose that normally your WTP for a cashmere sweater is $100. What would your WTP for
a cashmere sweater be if they marked it 50% off?
