Chapter 3

The Economics of Information

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 Ôaw of Supply and Demand

‡ Demand > supply: prices increase until

demand = supply.
± Economy growing: demand increasing.
± Seasonal goods: demand increases at certain
periods of time.
± Peak buying periods: buyers¶ purchasing
activities increase.

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 Pricing Anomalies

‡ Price wars are more likely in boom periods.

‡ Prices for food products with strong
seasonal demand tend to decline at seasonal
quantity peaks and rise during off-peak
periods.
‡ Retail sales occur primarily on weekends.
‡ Pre-Christmas markdowns tend to exceed
post-Christmas markdowns.

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 Pricing Anomalies

‡ Spring 1992 ± one full year of economic

recovery.
± Candy makers, supermarkets, hotel chains, car
rental companies and many other companies in
a wide range of industries were still cutting
prices!
± One executive said that the price cuts were to
³jump start´ demand.

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 Pricing Anomalies

‡ June 1997 ± prices for leading soft drink

brands fell 3 ± 4% over past 12 weeks
despite a growing economy and the lowest
rate of unemployment in 20 years.
‡ November (any year) ± 100 million turkeys
will be sold, yet supermarkets promote
³lowest prices´ and lose money on every
turkey sold!

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 Average Price Change
By Day of Week




 

 

 
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 Average Price Change
By Day of Week


 
 

 

 


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 Average Price Change
By Day of Week
#

#

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$  %
  $
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$  %
 $

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 Pattern of Retail Price Changes

‡ Prices fall as the weekend approaches.

‡ Prices peak on Mondays and fall as
weekend approaches.
‡ Weekend effect stronger during pre-
Christmas period.

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 Pattern of Retail Price Changes

‡ Weekend-holiday interaction is strongest for

Thanksgiving weekend.
‡ One-third of all products ever marked down
during observation period occurred Thanksgiving
weekend.
‡ 22% of all price promotions occurred
Thanksgiving weekend.
‡ Thanksgiving price promotions were three times
normal promotional activity.

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 48 Seasonal Food Products

‡ Feature displays:
± 7.7% in off-season, but 25.7% in peak season.
‡ Coupon intensity:
± 12.5% in off-season, but 30.2% in peak season.
‡ Significant increase in advertising during peak
season for most products.

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 48 Seasonal Food Products
‡ Shelf prices:
± Prices of 44 products declined significantly.
± Volume increased by 199% and prices fell by
7.5% during peak season.
± Price reductions ranged 3 - 15%.
± Price elasticity accounted for 33% of the
seasonal demand increase.
± Thus, 134% of demand increase due to non-
non-
price factors!

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 Possible Reasons for Observed
Pricing Anomalies
‡ Tacit oligopoly collusion
± The price setters in a market in which there are
a few large competitors are essentially
pessimists. If one reduces price, the other
competitors will match the reduced price, and
there will be no substantial increase in sales
volume for any seller. If one raises price, the
other competitors will not follow, and the firm
raising price will lose a substantial amount of
its sales volume.

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 Possible Reasons for Observed
Pricing Anomalies
‡ Shopper¶s search efficiencies
± If one firm reduces price and customers of
other sellers do not know of this reduction, then
there will be little increase in demand for the
price-reducing firm. If one firm raises price
and its customers recognize the price increase,
they will initiate a search for a better price-
quality relationship and switch to another seller.

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 Possible Reasons for Observed
Pricing Anomalies
ƒ Informative advertising
ƒSellers increase their information
advertising, reaching more interested
buyers, thereby reducing per customer
advertising costs. The increase in
advertising and promotion leads sellers to
perceive that buyers are more price
sensitive. Consequently, sellers believe that
price reductions are necessary to sell to
these buyers.
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 Possible Reasons for Observed
Pricing Anomalies
‡ If the seller can ³capture´ these buyers, they
will recognize the value they have received,
will become loyal, and market share will
increase permanently.
‡ However, would not each seller anticipate
their rivals would be thinking similarly?
‡ If all sellers reduce prices during peak
demand, would profits be enhanced?

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 Failure to Think Strategically
‡ The answer to both questions is no!
‡ People find it difficult to think strategically.
± Ôook ahead and reason back.
± Adopt the competitors¶ mind set.
‡ Firms do not do careful on-going competitive
research, information gathering or analysis.
‡ Firms do not do careful on-going price research,
information gathering or analysis.

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 Do Buyers Ôearn Through
Experience?
‡ Do buyers increase search activity, learn
where the best values are, and become more
price sensitive?
± Ôimited cognitive, time, energy, and monetary
resources.
± Ôimited ability to remember details of previous
purchase and use experiences.
± Information integration difficult and to subject
to error and bias.

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 Failure to Understand
Buyer Behavior
‡ Buyers do not understand uncertain quality
and misuse quality information.
‡ A few buyers do make good decisions
(~22%), and some others do learn to make
better decisions (~7%).
‡ However, most buyers use wrong decision
rules and do not learn (~62%).
‡ Consistently confused buyers (~9%).

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 Stigler¶s Model
‡ D ëuality of products offered by rival sellers is equal.
‡
Once a buyer samples a seller, all relevant information
about the firmŒs product is summarized by the price.
‡ Ô Price dispersion is a given (initially), and the buyer
knows the distribution of prices. This price dispersion may
diminish or even disappear if price information is quickly
disseminated by buyers to others, or sellers openly
advertise their prices. Thus, price dispersion is due
partially to buyer ignorance.
‡  The buyer decides how many stores to sample and
selects the lowest price available from those sellers.
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 Stigler¶s Model

‡  The buyer¶s maximum price (reservation price) she

is willing to pay is determined by the lowest price she
encounters; there is no minimum acceptable price.
‡  The expected benefits from a search are related
positively to the extent of the price dispersion.
‡  The extent of search is related negatively to the cost
of search.

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 Stigler¶s Model

‡ ù The gain from search decreases with continued

search (i.e., there are diminishing returns to search).
‡  The greater the expenditure on the product or
service the greater the return on search; therefore,
there will be more search for higher-priced products.
‡ D The more search a buyer undertakes, the lower
will be the average price paid.

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 Nelson¶s Contribution
‡ ëuality varies over sellers for similar
products
‡ Buyers may learn about quality through
search, experience, or not at all
‡ The more information buyers have, the
more price sensitive (elastic) they will be

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 Search Attributes

‡ Can be evaluated before purchase

‡ Buyers may be more aware of substitutes
‡ Sellers will likely imitate/copy successful
features
‡ There will be more similar substitutes
‡ Cross-price elasticity will be relatively high
‡ Examples: dentist¶s fees, air travel, TV
picture quality, audio system sound

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 Experience Attributes
‡ Can be evaluated only after purchase
‡ Buyers may be less aware of substitutes
‡ Sellers will be less able to imitate/copy
successful features
‡ There will be fewer and less similar substitutes
‡ Cross-price elasticity will be relatively moderate
‡ Examples: food taste, concert performance, dry
cleaning, hair permanent

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 Credence Attributes
‡ Usually can not be evaluated after receipt and
use
‡ Buyers are not able to compare or evaluate
alternatives
‡ Sellers will be more likely to customize
offerings
‡ There will be fewer and less distinctive
substitutes
‡ Cross-price elasticity will be relatively low
‡ Examples: legal advice, tax advice, health care
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 Implications for Buyer¶s Search
Behaviors

‡ For R
 
R,

 
R the incremental costs of
search are the out-of-pocket costs of transportation
and information and access fees plus the
opportunity costs of time of finding and evaluating
another product

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 Implications for Buyer¶s Search
Behaviors
‡ For     
R,
 
R the incremental costs of
search are the cost of obtaining price information
and access cost (the cost of obtaining product and
supplier information)

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 Implications for Buyer¶s Search
Behaviors
‡ 2R
R
= the difference in satisfaction
received between the best product found after
sampling some of the products and the expected
average satisfaction received if only one product
was chosen at random

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 Issues About Buyer Search
‡ 1. Extent that buyers search and the nature
of their search behaviors
‡ 2. Amount and nature of information that
buyers and sellers have differs
‡ 3. Pricing decisions based on assumptions
may not reflect how buyers and competitors
may actually behave

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 Additional Influences on Price
Search
‡ Buyer¶s knowledge about products and
market conditions
‡ Expertise
‡ Habit
‡ Relative brand uncertainty
‡ Social returns from the search and shopping
activity
‡ Ability to remember prices of products

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 Nature and Extent of Buyer
Search
‡ º R
 R  
 R
 R

ÚIf determinant attributes are search attributes,
then advertising is effective
ÚIf determinant attributes are experience
attributes, then various forms of in-store
shopping is more effective

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 Nature and Extent of Buyer
Search
‡ ë     


ÚIf sequential prices continue to be lower, the
buyer will continue to search.
ÚIf they are continuously higher, the buyer will
stop the search and return to the first product.
ÚIf they are random, the buyer will be uncertain
about continuing or discontinuing the search.

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 Reasons for Sellers¶ Mispricing
‡ If participants were ignorant of market conditions, prices
would change slowly. If participants were aware of market
conditions, prices do not change and demand exceeds
supply:
± 1. Buyers prefer to consume some products or services
as part of the crowd
± 2. Underpricing some products is preferable to only
allowing certain higher-income buyers having access to
them
± 3. Buyers¶ cost of waiting is low relative to seller¶s cost
of adjusting prices
± 4. Increasing prices might seem unfair
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 Do Managers Misread Buyer
Search?
‡ Theorists suggest that markets are comprised of
two segments of buyers: a segment who actively
searches for price information (price vigilants),
and a segment who does not search
‡ The price vigilants will know when price
differentials are inconsistent with quality
differentials and when market conditions change
‡ If the price vigilant segment is sufficiently large,
demand for a seller¶s products will be relatively
more price elastic

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 Summary

‡ Information has strategic value!

‡ Research on the role that price information
plays in buyers¶ behaviors is necessary for
firms!

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