PRODUCT PRICING

Effect of product pricing on consumer and business

Effect of product pricing on consumer and business

Introduction

If consumers are naive, firms will try to exploit it. Well-known examples are travelers who book a hotel room without thinking about the extra costs of add-ons such as parking or mini bar, consumers who buy a printer without being aware of the costs of new printer cartridges, or bank customers who open a new deposit without considering the fees of offered investment funds. As shown by Gabaix and Laibson (2006) (henceforth GL), the equilibrium pricing strategy of firms in such situations may be to compete purely on the price of the base good (i.e., the hotel room, printer, or deposit) and to shroud any information about the price of the add-on (i.e., the mini bar, printer cartridges, or investment funds). While the base good is priced below marginal costs the price of the add-on is above marginal costs.

The consequences for consumers are twofold: First, sophisticated consumers who rationally expect that add-ons are overpriced will search for substitution possibilities leading to inefficiency if costs of substitution for the add-on exceed a firm's costs of production. For example, travelers may carry their own drinks, refill cartridges themselves, or build their own investment portfolios. Second, naive consumers who buy the add-on at the high price subsidize the low-priced base good and thereby sophisticated consumers, which raise consumer protection concerns. The question is if and how a regulator may intervene to increase economic welfare and to help and protect consumers in their decision making.

Discussion

Impact of product price on consumer

Value pricing is an attempt to use product pricing to satisfy consumers' increasing demand for value, although value pricing is not a substitute for product quality, consistency, and cleanliness - all long favored methods of pleasing customers in the quick- ...