Willingness to pay
In behavioral economics, willingness to pay (WTP) is the maximum price at or below which a consumer will definitely buy one unit of a product. This corresponds to the standard economic view of a consumer reservation price. Some researchers, however, conceptualize WTP as a range.
According to the constructive preference view, consumer willingness to pay is a context-sensitive construct; that is, a consumer's WTP for a product depends on the concrete decision context. For example, consumers tend to be willing to pay more for a soft drink in a luxury hotel resort in to a beach bar or a local retail store.
Accurately gauging consumers' willingness to pay for a product or service is critical for formulating competitive strategies, conducting value audits, and developing new products. It is also important for implementing various pricing tactics, such as nonlinear pricing, one-to-one pricing, and targeted promotions. Not surprisingly, several approaches have been developed for this purpose.
In practice, some researchers favor the direct approach, asking consumers directly to state their WTP for a specific product through, for example, an open-ended (OE) question format. Others prefer an indirect approach, such as choice-based conjoint (CBC) analysis, in which WTP is calculated on the basis of consumers' choices among several product alternatives and a "none" choice option. However, neither method is foolproof. Many studies have shown that both direct and indirect approaches can generate inaccurate results for various psychological and technical reasons. More fundamentally, both approaches measure consumers' hypothetical, rather than actual, WTP and thus can generate hypothetical bias, which the economics literature defines as the bias induced by the hypothetical nature of a task.
A direct approach to elicit actual WTP is a mechanism that Becker, DeGroot, and Marschak (1964) propose (Becker–DeGroot–Marschak method, BDM), in which a participant is obligated to purchase a product if the price drawn from a lottery is less than or equal to his or her stated WTP. An indirect approach for determining actual WTP is the incentive-aligned choice-based conjoint (ICBC) analysis, in which participants are also obligated to make a purchase based on WTP inferred from their revealed preference, using the BDM mechanism. With more realistic economic incentives for survey respondents, these two approaches have generated good results in some applications. However, an actual WTP generated with these methods may not always be accurate, because it may differ from the WTP shown in real consumer purchases.
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