Analyzing and Modifying Consumer Willingness-to-Pay (WTP)

Exercise 1: Analyzing Yourself as a Consumer

Exercise 1 (40 points)

In this exercise, you will analyze yourself as a consumer. It is a self-reflective, experiential exercise: you experience the process of constructing a subject’s indifference map while you are the subject.

1. First, pick two goods (products or services) that matter to you; for example, something that you buy every week (e.g., food items). What are X and Y?
2. Second, draw a 2-dimensional graph with X and Y In this graph, prepare one indifference curve; explain how you derived the curve (please follow the method we discussed in class).
3. Third, based on that first indifference curve, draw, in the same graph, more indifference curves to get a sense of how the indifference map representing your preferences looks like; explain how you derived the This map is a picture of you as a consumer of X and Y.

Hint: This is a replication of the exercise we did in class. Please do not use the same example we had in class.

Exercise 2 (60 points)

In this exercise, you will analyze and try to modify a good using the concept of willingness-to-pay (WTP). It is an experiential exercise: you experience the process of analyzing and modifying WTP. The main objective is for you to practice and polish your skills related to measuring, analyzing, and shaping consumers’ WTP.

There is a significant learning-by-doing component of this exercise and you will need help from your spouse, child, sibling, other family member, or a friend. The person who helps you will be the subject of your study.

a. Pick a First, you should pick a good (product or service) that you will analyze. It is crucial that the good you choose is something that

1. 1. you personally never or almost never use/buy and do not know much about, but
   2. the subject is very familiar with and uses it 1

In (a), you need to explain a good you chose. Here, it is not the place to talk about the “needs” (you will do that in part (c)). What is required is a verbal description of the good – the way you would describe it outside of an economics classroom.

Try to be as specific and detailed as possible. For example, “milk” or “carton of milk” is not as specific as desired; rather, you might want to describe the brand (Lala), size (500 ml), category (non-fat), and other attributes that matter.2

If you think that I might be unfamiliar with the good (ideal scenario from my perspective as this would be more fun and learning opportunity for me), then attaching a picture might be a good idea. Keep in mind that I need to be able to visualize what the good is; your task in (a) is to help me with that visualization.

The good can be whatever you choose as long as conditions (i) and (ii) are met. For example, food item that you do not eat because of your preferences or allergies; or a cosmetic that you are not familiar with; or software that your subject uses in their professional capacity, but you never use it. (Check footnote 1 for some ideas.) I would recommend products (tangible goods) instead of services as the latter are usually more difficult for analysis. But, the choice is completely up to you.

Exercise 2: Analyzing and Modifying WTP of a Good

In a typical research study, we always describe the subjects (demographic variables). Since the study involves just one subject who might not want you to share any information about her/him, I do not require any description of the subject. There will be no score subtraction if you do not talk about the subject.

However, since this might also help with your analysis, consider as an option to provide a brief explanation of who the subject is.

Focus on what matters. For example, your relationship with the subject or their name should not be disclosed because they are not relevant pieces of information for the WTP analysis. You need to keep the study anonymous and professional. Do not provide any personal details or information about the subject that she/he would not want you to share.

b. Measure WTP. Second, figure out the subject’s willingness-to-pay (WTP) for the good described in (a). Here, I would like you to explain in detail the process that you and the subject went through.

I leave it up to you if you want to use real money when establishing WTP or conduct a hypothetical exercise (this should make more sense if the good is expensive; here, you can use “fake” money). What matters is that you go through the experience of evaluating subject’s WTP and describe that experience.

There are many procedures that you can use. One procedure I insist that you do not use is “asking.” Do not ask the subject about her/his WTP; your challenge is to derive that WTP from the subject’s behavior. You must assume that the subject either does not want to share their WTP with you or do not know their WTP – your main challenge is to deduce subject’s WTP from their behavior.

Recall a simple method we used in class:

1. Subject chooses between good and cash.
2. Cash starts at 1 SAR, then 2 SAR, and so (Or, cash starts at a higher value if you expect the good to be more valuable.)
3. For low values of cash, subject chooses the But, when the amount of cash is high enough, the subject switches to cash – this is where you stop the experiment.

For example, consider the following table tracking a subject’s behavior. (Your analysis should include a table like that.)

Subject switched at 6 SAR and this is where the experiment ends. From the table above, we know that WTP is strictly bigger than 5 and smaller or equal to 6; i.e.

As discussed in class, asking the same subject to make several choices in a row is problematic from the methodological perspective. Ideally, each time the subject makes a choice, they should forget the past choices – of course, it is impossible (and that is why we use focus groups with representative consumers where each subject makes just one choice). Yet, for the sake of practicing the method of estimating WTP, we can accept the fact that you have access to just one subject whom you ask to make several choices.

c. Main attributes/needs. Third, determine two (2) main attributes of the good that affect its WTP. What are these attributes? What needs do they satisfy? Here, you are having a discussion with the subject. (Think about the good you are analyzing as a “basket of attributes” in the two-dimensional graph where each axis is an attribute.) Summarize the discussion and its conclusions.

d. Shape WTP. Fourth, given the two attributes you identified in (c), propose how to increase WTP by changing these attributes. The changes can be tangible or only reflected in the consumer’s perception.

In short, what would you do to make a good better (higher WTP) for the consumers? Note that I do not ask about the costs of making the changes you propose – this is not relevant for this exercise (but, of course, relevant later when we determine the optimal strategy to boost WTP).

Be imaginative and innovative. Do not replicate what companies 

Bonus Exercise (10 points)

In my opinion, this is a difficult exercise so you might want to be especially careful about it. However, once you “get it,” the answer should come easily In this exercise, I would like you to think about a case when no sense and an indifference curve looks like in Figure 2 (flat line, parallel to X axis). First, you should recognize that, in, monotonicity is violated (how? where?); second, you should conduct self-analysis and try to find goods X and Y for which this indifference curve describes your preferences.

Your task is to tell me what – in your case – these goods X and Y are. Importantly, explain why your indifference curve for X and Y looks like in Figure 2. (Note that I am unable to accept an answer without an explanation. I must see some reasoning behind your answer.)