Pricing Experience Goods 1:F - 1(40) Economic Foundations for Entertainment and Media Pricing and Value for Experience Goods

Pricing Experience Goods1:F - 1(40)

Economic Foundations for Entertainment and Media

Pricing and Value for Experience Goods


Demand and Value

Demand and Demand Curves

Prices Reservation price “Value” “Bargains

Pricing Pricing strategies Price discrimination Pricing innovations


An Important Aspect of Prices for Experience Goods: The Implicit Price

Nominal price: $675+ Implicit price: $ far more than $657

Transportation Time – at least 5 hours in total.

This divergence is characteristic of experience goods. They take time to consume. The time used up having the experience is part of the price. Choosing to see this concert means not using the time for some other use. TIME IS THE REAL CONSTRAINT.

Lady Gaga and Tony Bennett, The Axis, Las Vegas, 4/10/15


“Value”

What is it? From the consumer’s viewpoint From the seller’s viewpoint

Creating Value Capturing Value

Meaning Sources of value


Pricing and Value from the Consumer’s Viewpoint


Reservation Price:Price Strategy Under Uncertainty

Your reservation price is $2,500.

Auction to take place in 5 days.

What would you do now?


Price and Value

The operative word in your question is “true” directly placed before the word “value.” You suggest the “true value” of a specific comic book is a few thousand dollars — but all that means is someone might be willing to pay that much for it, based on extrinsic qualities (rarity, for example). To the person running the flea market, the “true value” of the comic book is virtually nothing. There is no “true value” for any object: it’s always a construct, provisionally defined by a capricious market and the locality of the transaction. Things cost what they are being sold for, and they’re worth whatever the seller can get.…

Look at it like this: Let’s say the person at the flea market was selling that same rare comic for $2,000. You, however, would be willing to pay far more than that; because of its sentimental value and the status it will bring among your comic-book-collecting peers, you’d gladly fork over $5,000. Would you feel the need to inform the seller, “You know, I’d actually pay you $3,000 more than what you’re asking”? I don’t think you would, and no one would expect you to.

Is it ethical to buy something at a yard sale or a flea market at the seller’s asking price if you know the value of the item to be significantly higher than what is being asked? Let’s say, for example, someone is selling an old comic book worth thousands of dollars but asks for only a quarter because he or she does not know the true value. Is it incumbent on the seller to do his or her research? If the seller does not, is it fair game?


Consumers Valuation of Products

Surplus Value: Consumers must perceive “value” over price.

By Attributes: Hedonic Pricing

$3000+

The high price was one of the reasons for market failure. Consumers did not get enough surplus value.


Appropriable Profits in a Market Come from Consumer Surplus

Final demand for a good or service reveals the surplus Stages in the delivery to the consumer may accumulate the surplus Total appropriable rent in a market is generated at the final sale

Price

Quantity

Pm

Qm

This is the total consumer surplus that can be extracted from all stages of this market.

Different buyers have different reservation prices. Therefore, demand curves slope downward.


Event Consumer Surplus

0 8 16 24 32 40 48 56 64

90

80

70

60

50

40

30

20

10

0

Price Per Ticket

Tickets (1000s)

Price=15; 9,000 people willing to pay 70 20,000 people willing to pay 60 (including the 9,000) 40,000 people willing to pay 30 (including the 20,000) 56,000 people willing to pay 20 (including the 40,000) 64,000 people willing to pay 15 (including the 56,000)

= 9,000(55) = 495,000 = 11,000(45) = 495,000 = 20,000(15) = 300,000 = 16,000(5) = 80,000 = 1,370,000

15

How can promoters capture the consumer surplus in markets like this?


Scalpers and

Sellouts

500

1000

1600

1100

2000

Mork buys ticket to Star Wars Bar Scene concert for $500. Values ticket at $1,000If Mork can sell the ticket for > 1,000, he will do soIf Mork can sell the ticket for $500 - $1,000 he will just go to the concert.

Mindy values the concert at $1,600 offers Mork $1,100.Mork sells the ticket. New surplus for Mork is $100Mindy buys for $1,100 a ticket that she values for $1,600The transaction creates $100 + $500 = $600 in new surplus value.

No one loses. Trade makes both people better off. What could be wrong?

Tickets

Price


Scalping: Reallocates the Surplus

Why does Ticketmaster care?

Should Hanna Montana, Bruce Springsteen and the Spice Girls care?


A Merger Made in Heaven


Why We Worry About this Merger

Horizontal Issues: Will the large market share enable them to raise prices?

Vertical Issues: Will control of venues and artists enable anticompetitive practices? Foreclosure from markets Bundling



Live Nation Also Owns Tickets Now

Ticketmaster and Live Nation were opposed by DOJ

Tickets Now is LNE’s own scalper.

This is a vertical integration case.

We will revisit later in the vertical integration section.


Economic Foundations for Entertainment and Media

Strategic Pricing for Experience Goods


Demand Concepts

Consumer “response” to changed circumstances = the extent to which quantity demanded changes when price or income or something else changes

“Elasticity” is the measure of “responsiveness” Response to changes in price Changes in Income – Recreation is the Normal Good (“Why do we

work?”)


Elasticity

TicketPrice

Quantity of tickets

Less elastic

More elastic

Less elastic More elastic

Change in Price

Change in Quantity


Demand Curves from the Seller’s Viewpoint

Elasticity of demand %change Q / % change x Income, price

Elasticity is a measure of seller’s market power

Consumer surplus measures consumers’ benefit from consumption

Sellers with market power can (only) obtain profits in a market by capturing consumer surplus

The less elastic is demand, the greater is the potential surplus


Applying Price Theory to Experience Goods

Different results from consumption: Humdrum goods vs. Experience goods

Implications for pricing and price strategies The “price” Monopoly pricing results


“Competitive Outcome”

Many sellers, many buyers Any seller can sell as much as they wish at the

“market” price No seller can sell at a price above the market

price No buyer has (or would take) an opportunity to

bid above the market price – there is no shortage so no incentive to do so.


Market Power over Price

Seller (Monopoly) = Control over price Set any price they wish Price strategically recognizing that quantity sold will

depend on the price they set

Buyer (Monopsony) = control over purchase price Typically labor markets Ford modeling agency Professional sports Silicon Valley engineers conspiracy (HP, Apple,…)


Monopoly Pricing

Monopolist will price where MR = MC. If MC > 0, this must be in the elastic region of the demand curve. For a performance, MC = 0.

Quantity

Price

|Elasticity| > 1(Elastic) |Elasticity| < 1 (Inelastic)

If the |elasticity| is < 1, the price is too low. MR is < MC.

Basic theory would not predict that a monopolist would price in the inelastic region of the demand curve.

D

MR

MC


Price Determination-Standard In the presence of “market power”

Market power is the ability to elevate

price above the competitive norm.

Marginal Cost

Demand

Marginal Revenue

P*

Qm

Short run profit is obtained by transferring consumer surplus from buyers to the seller.


An Index of Market Power

Interest in Price,

Quantity = Q(Price) = Q(P) Demand Curve

Cost = C(Quantity) = C(Q(P))

Look for the profit maximizing price (best price strategy)

Profit = = P * Q(P) - C(Q(P))

Profit is maximized where d /dP = 0

d /dP = Q(P) + P*dQ/dP - dC/dQ*dQ/dP = 0

dC/dP is marginal cost, MC. Note also, dQ/dP < 0

Solve the equation and P =

MC - Q/[dQ/dP] which is > MC

P - MC 1Index: =

P Price Elasticity

Economic Result: Greater profit margin when demand is less elastic


Pricing Strategies

Exploit pockets of market power Take advantage of market imperfections Exploit unusual market configurations


New Broadway Math

2001: Record price: $100 Producers $480 2006 Average price about $65 2006: “Premium Seats” (The Producer) $200-$500 seats are now routine. Theater owners had underestimated the number of inelastic buyers.


Concert Ticket Prices: Live Nation Effect

Connolly, M. and Krueger, Al, “Rockonomics” http://www.irs.princeton.edu/pubs/pdfs/499.pdf



The Pricing Conundrum in Major League Baseball

• Empirical Models of Demand Produce Price Elasticities between -1 and 0. Team owners could raise revenue by increasing price Are team owners pricing irrationality?

• (I assume models that produce positive elasticities are misspecified)


“A current finding in estimates of the gate demand for sports events is pricing in the inelastic portion of demand.” This finding has puzzled analysts who study the demand for sporting events because it suggests that owners could raise ticket revenue by raising ticket prices.

Estimated Long-run Elasticities of AttendanceElasticity Real Ticket Price ANA -0.88ATL -0.57 BAL 0.72BOS 0.57CIN 1.95CLE 2.74DET 0.78HOU -2.31KCR -1.46MIL -1.14MIN -0.46NYM 0.85NYY 0.73


A theory that might explain pricing in the inelastic region

Monopoly Pricing Model for Tickets=Q(P,q,m), P=Price, q=quality, m=market conditions

Pricing is cognizant of a second good; Concessions C(R,P,q), R=concession price

Total profit from both Tickets+Concessions Ticket Price might be low to draw people to the

concessions. (We will revisit this model later in the context of

movie theaters.)


Are owners really pricing irrationally?




Two Part Pricing Strategy: Movie Studios to Retailers –

Videotapes

Tapes: Marginal Cost = $3.00 One time: $70.00 - $80.00 Revenue Share: $8/tape + x% of rental Unclear which was the better price strategy


The Disneyland Dilemma

Higher Fixed Fee (and lower Marginal Fee): Control the number of people who come to the park. Extract $$ from consumer surplus at the gate.

Higher Marginal Fee (and lower Fixed Fee) More people come to the park and spend more on rides.

Theoretical result: Charge a very high Entry Fee and zero Marginal Fee. Disney: Two part fees 1955-1982; One part 1982-now

Two part tariff (price): Entry Fee Fixed Marginal Fee Per attraction

A Disneyland Dilemma: Two-Part Tariffs for a Mickey Mouse MonopolyWalter Y. Oi The Quarterly Journal of EconomicsVol. 85, No. 1 (Feb., 1971), pp. 77-96


Mixed Pricing Strategy: Adventureland, Farmingdale NY

Allow customers to sort themselves into low and high elasticity groups. (High ride price elasticity buyers will choose the POP ticket.)


Rye Playland, Rye NY

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Pricing Experience Goods 1:F - 1(40) Economic Foundations for Entertainment and Media Pricing and Value for Experience Goods