Often in economics (and certainly in marketing) researchers ask consumers their willingness to pay (WTP) for an item. This can be done following an experimental manipulation to assess the impact of some variable or simply to determine how to price an item. I often use such a question in my own research and generally don’t think much of it.
Recently, however, I had an experience which makes me question the degree to which people truly know how much they are willing to pay for anything. I was bidding for an item on eBay and, being the behavioral scientist that I am, thought about what I should set as my maximum bidding price (I’m far too lazy to snipe). I knew that the item was selling for about $60 in other auctions so I quickly anchored on that value and bid about the same.
Unfortunately, a few hours later I was outbid. At this point, I started asking myself: “well am I really only willing to pay $60 for this item? What about $70?” And the truth was that I had absolutely no clue what I valued this item. From a purely economic point of view, I didn’t know how much utility I would extract from using the item. Would the marginal in crease in cost be offset by the utility I would derive?
There already is a tremendous amount of research on context effects in judgments (i.e. our subjective enjoyment/utility is highly variable and influenced by the environment that we are in), but to what degree is the uncertainty of willingness to pay understood? In auctions we know that people get attached to their item they are bidding on (i.e. endowment effect) and bid more than they should. But this applies a normative standard on how much they “should” bid.
First, I’m suggesting that people have a range that they might be willing to pay for an item rather than an absolute number. This is nothing new of course since we know that variance exists in people’s responses to just about everything. But if we stop here we would say that if we wanted to assess someone’s WTP by using a stepwise elicitation procedure where we ask a person if they would be willing to pay $1, $2, $3, etc… for an item and that would yield a maximum WTP.
However, I think that there’s more to the story. Even after a person has given his/her maximum WTP using this procedure (or any other) they still are uncertain about the utility they will derive from an item and so might adjust up or down based on some contextual cues (endowment in my auction example). If this is true, then price setting is as much of an art form as it is a science.
And please, don’t start on the supply/demand arguments as that will only make me whip out a list of ~500 papers that show how poor the demand side (people) is at figuring out anything.
So what do you think? Do people know what they are willing to pay for items?
I think it depends on the good and the context. If it’s a standardised thing that people buy regularly like a loaf of bread, I think people will know their wtp pretty well. However for something that you haven’t bought before then there could be uncertainty about your wtp. In an open auction if bidders’ wtps are correlated then the bids of others can reveal information that allows you to update your own estimate of wtp, so your wtp could go up or down during the auction for this reason. In addition, as you said the endowment effect and also a competition effect where people get utility from simply beating others could affect wtp in auctions.
Hey Aaron,
So here’s my problem with the “people know what their WTP is for common goods (bread)” argument. If I went to a supermarket and asked someone what the absolute maximum they would be WTP would be for a load of bread, they might say $4. Fine. So $4 is the max wtp, right? Well, I bet if I went to that person and asked if they would buy it for $4.10, they would say “yes”. There’s obviously some threshold when the answer flips to know, but i’m arguing that people don’t know what that is. So if I asked this person to pay $4.25, he/she might. If I asked $5, he/she still might. Clearly if I asked about $100, he/she would say no. But this all hinges on the fact that he/she initially said “$4″.
Also, with market goods (e.g. bread) people are conditioned to be WTP the market price (which, I am certain is not (solely) determined by demand). So, if anything they will just respond with something close to the ticket price of the item, which necessarily isn’t their absolute WTP.
So how do we trust people’s responses when they themselves likely have no clue what they should pay for something?
Ok, I think I agree. Definitely the framing of the question is important. Maybe the right way to do it is to start at a very high price and go down until people say yes (like a Dutch auction)?
I still think that people must know their wtp somehow, because demand slopes down. I mean, if the price of bread went up, quantity sold will surely fall, so some people figured out that the new price was above their wtp.
Maybe it’s just simply impossible to extract this information by asking people questions? Maybe the only way to get the truth is to play with actual prices.
I agree that there must be a max WTP, but I’m not sure that letting the market decide works either. There are countless examples of upward sloping (at least at parts of the curve) demand curves (luxury goods are a classic example). I don’t think it’s correct to assume a downward (or even continuous) demand curve without empirical investigation. So, to that degree, I agree that playing with actual prices may be the only way to go.
I think this interesting from a psychological point of view, but what’s even more interesting is how much classic economic theory takes things like this for granted. Basic assumptions (like downward sloping demand and known utility) seem to miss a lot of nuanses in human behavior. Of course, this is precisely why I study Judgemtn and Decision Making; I find these types of questions absolutely fascinating.
Thanks for the discussion Aaron!