Wednesday, March 05, 2003

Pricing: Psychology vs. Economics

Which Price is Right?

(from FastCompany) "Monroe tells a pricing story that shows how even the simplest situation can confound accepted wisdom about prices. "A company is making two versions of the same product," says Monroe. "One has a little more gold and foil on it, but they're essentially the same. One is $14.95; the other is $18.95." Not surprisingly, the $14.95 item is selling better. It's also the lower-profit product.
"Then a competitor comes in with a third product. Again, it's essentially the same thing, but a fancier version. And it's much higher priced: $34.95."
For our original company, asks Monroe, "what becomes the best-seller? Why, the $18.95 version, of course."
It's a small story, but it's true. In fact, you can feel how right Monroe is. "The point," he says, "is that economic theory says that can't happen. But it does."
The neat curves and crisp laws of supply and demand, elasticity, and rational behavior that everyone learns in microeconomics class don't work in the real world. "