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Bundling:Consumption Decisions When Products are Bundled

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Microeconomics ­ECO402
VU
­
Lesson 37
Bundling
Bundling is packaging two or more products to gain a pricing advantage.
Conditions necessary for bundling
­  Heterogeneous customers
­  Price discrimination is not possible
­  Demands must be negatively correlated
An example: Leasing Movie X & Movie Y
­  The reservation prices for each theater and movie are:
Movie X
Movie Y
Theater A
$12,000
$3,000
Theater B
$10,000
$4,000
Renting the movies separately would result in each theater paying the lowest reservation
price for each movie:
­  Maximum price X = $10,000
­  Maximum price Y = $3,000
Total Revenue = $26,000
If the movies are bundled:
­  Theater A will pay $15,000 for both
­  Theater B will pay $14,000 for both
If each were charged the lower of the two prices, total revenue will be $28,000.
Relative Valuations
­  Negative Correlated: Profitable to Bundle
­A pays more for X ($12,000) than B ($10,000).
­B pays more for Y ($4,000) than A ($3,000).
­  If the demands were positively correlated (Theater A would pay more for both films as
shown) bundling would not result in an increase in revenue.
Movie X
Movie Y
Theater A
$12,000
$4,000
Theater B
$10,000
$3,000
If the movies are bundled:
­  Theater A will pay $16,000 for both
­  Theater B will pay $13,000 for both
If each were charged the lower of the two prices, total revenue will be $26,000, the same as
by selling the films separately.
Bundling Scenario: Two different goods and many consumers
­  Many consumers with different reservation price combinations for two goods
171
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Microeconomics ­ECO402
VU
Reservation Prices
r2
Consumer
(reservation
C
price Good 2)
$10
Consumer A is
willing to pay up to
$3.25 for good 1 and
Consumer
up to $6 for good 2.
$6
A
Consumer
$5
B
$3.25
r1
(reservation price
Good 1)
$3.25
$5
$8.25 $10
Consumption Decisions When Products are Sold Separately
R1 < P
R1 > P
r2
Consumers fall into
1
1
four categories based
R2 > P2
R2 > P2
on their reservation
price.
II
I
Consumers
Consumers
buy
buy
P2
R1 < P
R1 > P
1
1
R2 < P2
R2 < P2
III
IV
Consumers
Consumers
buy
buy
r1
P1
Consumption Decisions When Products are Bundled
r2
Consumers buy the bundle
when r1 + r2 > PB
I
(PB = bundle price).
Consumers
PB = r1 + r2 or r2 = PB - r1
buy bundle
Region 1: r > PB
(r > PB)
Region 2: r < PB
r2 = PB - r1
I
Consumers do
not buy bundle
(r < PB)
r1
172
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Microeconomics ­ECO402
VU
The effectiveness of bundling depends upon the degree of negative correlation between the
two demands.
Reservation Prices
r2
If the demands are
perfectly positively
correlated, the firm
will not gain by bundling.
It would earn the same
profit by selling the
goods separately.
P2
r1
P1
Reservation Prices
r2
If the demands are
perfectly negatively
correlated bundling is the
ideal strategy--all the
consumer surplus can
be extracted and a higher
profit results.
r1
Movie Example
(Movie X) r2
10,000
Bundling pays due
to
negative correlation
5 000
B
4,000
A
3,000
r1
10,000 12,00
14,000
5,000
(Movie Y)
173
Table of Contents:
  1. ECONOMICS:Themes of Microeconomics, Theories and Models
  2. Economics: Another Perspective, Factors of Production
  3. REAL VERSUS NOMINAL PRICES:SUPPLY AND DEMAND, The Demand Curve
  4. Changes in Market Equilibrium:Market for College Education
  5. Elasticities of supply and demand:The Demand for Gasoline
  6. Consumer Behavior:Consumer Preferences, Indifference curves
  7. CONSUMER PREFERENCES:Budget Constraints, Consumer Choice
  8. Note it is repeated:Consumer Preferences, Revealed Preferences
  9. MARGINAL UTILITY AND CONSUMER CHOICE:COST-OF-LIVING INDEXES
  10. Review of Consumer Equilibrium:INDIVIDUAL DEMAND, An Inferior Good
  11. Income & Substitution Effects:Determining the Market Demand Curve
  12. The Aggregate Demand For Wheat:NETWORK EXTERNALITIES
  13. Describing Risk:Unequal Probability Outcomes
  14. PREFERENCES TOWARD RISK:Risk Premium, Indifference Curve
  15. PREFERENCES TOWARD RISK:Reducing Risk, The Demand for Risky Assets
  16. The Technology of Production:Production Function for Food
  17. Production with Two Variable Inputs:Returns to Scale
  18. Measuring Cost: Which Costs Matter?:Cost in the Short Run
  19. A Firm’s Short-Run Costs ($):The Effect of Effluent Fees on Firms’ Input Choices
  20. Cost in the Long Run:Long-Run Cost with Economies & Diseconomies of Scale
  21. Production with Two Outputs--Economies of Scope:Cubic Cost Function
  22. Perfectly Competitive Markets:Choosing Output in Short Run
  23. A Competitive Firm Incurring Losses:Industry Supply in Short Run
  24. Elasticity of Market Supply:Producer Surplus for a Market
  25. Elasticity of Market Supply:Long-Run Competitive Equilibrium
  26. Elasticity of Market Supply:The Industry’s Long-Run Supply Curve
  27. Elasticity of Market Supply:Welfare loss if price is held below market-clearing level
  28. Price Supports:Supply Restrictions, Import Quotas and Tariffs
  29. The Sugar Quota:The Impact of a Tax or Subsidy, Subsidy
  30. Perfect Competition:Total, Marginal, and Average Revenue
  31. Perfect Competition:Effect of Excise Tax on Monopolist
  32. Monopoly:Elasticity of Demand and Price Markup, Sources of Monopoly Power
  33. The Social Costs of Monopoly Power:Price Regulation, Monopsony
  34. Monopsony Power:Pricing With Market Power, Capturing Consumer Surplus
  35. Monopsony Power:THE ECONOMICS OF COUPONS AND REBATES
  36. Airline Fares:Elasticities of Demand for Air Travel, The Two-Part Tariff
  37. Bundling:Consumption Decisions When Products are Bundled
  38. Bundling:Mixed Versus Pure Bundling, Effects of Advertising
  39. MONOPOLISTIC COMPETITION:Monopolistic Competition in the Market for Colas and Coffee
  40. OLIGOPOLY:Duopoly Example, Price Competition
  41. Competition Versus Collusion:The Prisoners’ Dilemma, Implications of the Prisoners
  42. COMPETITIVE FACTOR MARKETS:Marginal Revenue Product
  43. Competitive Factor Markets:The Demand for Jet Fuel
  44. Equilibrium in a Competitive Factor Market:Labor Market Equilibrium
  45. Factor Markets with Monopoly Power:Monopoly Power of Sellers of Labor