The Zero Price Concept - Essay Example

? Economics Economics Introduction At its core, the price of zero, which is also referred to as the zero-price effect, refers to an observed theory that holds that decisions regarding free products are quite different. This difference emerges primarily from the fact that people do not merely subtract costs from the benefits they receive from a good or service, but rather perceives the benefits linked to free products as significantly greater. The implications of the price of zero are exemplified by the inclination to consider zero as acting as a special price, which in turn results in overreaction to free products and services as though zero price instantly denoted increased value. The price of zero has a peculiar effect on demand where the concept of free has the impact of bending the demand curve as demand increases in an extremely non-linear way. This paper will examine the concept of the zero price, discussing its effects on demand and price, thereby demonstrating how price has the capacity to allocate and ration resources. The price of zero refers to the phenomenon in which the demand for a product or service is substantially more at the price of zero than a price even minimally greater than zero. On a graph, a zero price effect appears in the form of a discontinuity on the demand curve at the price of zero. In essence, the zero price effect can be considered as a special instance in the law of demand. The price of zero also encompasses a myriad of explanations that are based on psychological, behavioural and cognitive biases (Poundstone, W 2010, 75). An utterly rational justification for the zero price effect lies in the fact that when the marginal utility of extra units of consumption is positive albeit exceedingly low, lower than a nonzero unit of price (currency) can be charged feasibly (Engelson 1995, 54). Another prominent explanation for the zero price phenomenon is the transaction costs. If the purchase of products and services encompasses the exchange of tangible currency or money, then the exchange of money in itself impresses transaction costs, which bear a minimum value. For example, when purchasing something online, people typically have to provide their credit card information or alternatively, log in to the online purchasing site through a payment service. On the other hand, when purchasing something in person, the exchange of bank notes or coin is exceedingly necessary (Poundstone, W 2010, 147). These direct, as well as indirect costs exert a positive effect in terms of the effective price, especially in case of any form of nonzero price. Therefore, a real price drop to zero can ultimately represent a substantive drop in the effective price of the product or service. This problem inherent in transaction costs can be resolved through a myriad of ways, for instance, by making use of cards or accounts in the event of bulk payments that are made once before an account balance is sustained in order to keep track of other small purchases (Engelson 1995, 91). This strategy presents the most common method through which electricity, gas, phone usage, as well as other utilities are billed. The last explanation for the zero price occurrences is psychic costs. Handling and thinking about money has the potential to be quite stressful. This is because considering whether small items are worth small amounts of money can in itself exert a psychic cost, which can force people to steer away of considering or even making purchases. When people are faced with the option of choosing one among numerous products or end up purchasing nothing, according to perspectives provided under standard theories, it is widely acceptable that people will select the option with the greatest cost-benefit variation. However, it is evident that decisions regarding free or zero price products differ quite substantially since people typically do not merely subtract costs from the benefits offered by the product, but rather they consider the benefits linked with free products as profoundly greater (Engelson 1995, 114). When the demand for two products is contrasted across conditions, which sustain the price disparity between the products, but the prices are varied in a way that the cheaper product is priced at a zero price or low positive, then the product priced at a zero price attains the highest demand. In contrast, with regard to the standard cost-benefit perspective, based on the zero-price condition, considerably more people opt for the cheaper option, while very few people opt for the expensive option. Therefore, people typically tend to act as though zero pricing of a product not only lowers its costs, but additionally increases its benefits. A number of psychological antecedents are the reasons behind this perspective. These include, among others, affect, mapping difficulty and social norms. However, people typically lose sight of the fact that if goods and services are always to be priced at a price of zero, particularly at the point of delivery, demand will surpass supply and some form of administrative allocation or rationing will become unavoidable. As the prices of goods and services descend from the cost condition to the free condition, the costs typically decrease by a similar magnitude for all products. Consumers typically believe that the benefits of the free product essentially increase more than that of the expensive product while the net benefits of the cheap product grow substantially (Engelson 1995, 54). With regard to demand, the zero-price model anticipates that while prices are lowered, the demand for the cheap product increases while the demand for the expensive product reduces as consumers shift from the expensive product to the cheap one. In the event of a zero price, demand exceeds supply and rationing and administrative allocation becomes imperative. Prices, therefore, serve as the primary source of ration and resource allocation within the market economy. The supply and demand model is one of the most powerful economic tools used in the analysis of markets. Demand and supply determine the price of goods and services within the economy. On the other hand, these prices typically function as signals, which influence the allocation of scarce resources within the economy. This is because prices determine who produces which product and the quantity of each product produced. Products that are plentiful in the economy, and which few people desire, have relatively low prices and are thus affordable by almost all people. Therefore, one function of price is to ration scarce resources; when product prices are high, few people will receive a ration. On the other hand, prices also serve a signalling function in the economy, telling consumers and sellers what they need to do (Engelson 1995, 129). Low prices suggest the event of oversupply within the market or inadequate demand, or both. Therefore, buyers perceive the message to purchase since the product is cheap, while sellers get the message to halt supplying the product. The rationing function of price responds to an important question, which economic systems typically address: which consumers receive the goods and services produced? In order for goods to be freely available, there needs to be sufficient amounts to go around freely to all people who want them. Within market systems in the economy, there are products that consumers are willing and capable to pay the market price, otherwise, sellers typically seek out pertinent alternatives, for instance, zero pricing. In such an event, since prices are at zero, more goods are demanded, which requires prices to ration such demand and supply. Sellers are tasked with deciding which people will have to cut back on their demand and by what quantity. Therefore, as a consequence of the increasing demand, producers and sellers are forced to increase the price from a zero price to a nonzero one. As a consequence, a fewer number of people will be ready and capable of paying the new and higher price for the product. This means that price itself will have effectively rationed the available product in the economy (Engelson 1995, 165). Over and above the function of rationing products and services, prices additionally handle two other pertinent questions to which economic systems must provide responses: what is produced, and in what ways is the product produced? An essential role performed by price is the provision of responses to these questions (Phlips 1983, 114). Prices essentially transmit information regarding shifting resource scarcity, as well as shifting consumer values. This takes into consideration the event of a rise in resource scarcity as a consequence of increased demand from zero pricing. It considers what would happen if the supply of a product starts to get depleted by extensive demand (Engelson 1995, 144). Within an unregulated market, the price of such a commodity will start to increase. This consequently signals consumers to utilize less of the product and shift to substitutes, which are relatively abundant. This is the optimal situation since people will start conserving scarce resources. The increasing price further signals producers to attempt to produce additional products and to create alternatives, which require administrative expenses (Nagle, Hogan & Zale 2010, 45). This is also an optimal situation since it is the increasing prices, which offer these incentives for both consumers and producers. In addition, a consideration of the change in consumer desires characterised by the explosion of substitutes. In such an event, customers will desire more substitutes than the original product. The decrease in the demand of original products will make the price of the substitute increase, and as a consequence, the quantity supplied will reduce. Since people will desire fewer original products, few resources will be devoted to producing and supplying them. Evidently, it is price, which transmits such information from consumers and sellers (Engelson 1995, 189). In addition to the goods that get produced, prices also address the issue of how goods are produced. There are various ways of producing goods. Producers can use capital-intensive production methods or labour-intensive methods. Part of the reason why organizations use these different production practices is that the price of labour is predominantly lower than that of capital (Engelson 1995, 157). Therefore, as the price of labour goes up, producers will essentially substitute capital for labour, thereby becoming extremely capital intensive in their production endeavours. However, the event of market control occurs when sellers and buyers have the capacity to influence the price of goods and the quantity sold (Phlips 1983, 95). The capacity to control the market, particularly the market price deters the market from equating the price of demand and supply. Conclusion The price of zero has a number of core justifications. Perhaps the most viable justification concerns the consideration of the marginal utility of extra units of consumption as positive compared to the nonzero price of currency (Engelson 1995, 54). The transaction costs also explain the phenomenon of the price of zero. The price of zero enhances demand thus exceeding the level of supply. Inherent in its capacities, price has the power to determine ration and allocate resources. Prices function as vital ration controllers and resource allocators by managing the demand and supply curve in a manner that ensures that no individual gets too much of a product or service such that the ration denies other people access to the product. This is because price has the power to determine the product and quantity produced and the manner in which it is produced (Engelson 1995, 144). Figure 1 The following graphs show the event of zero profits as a consequence of zero pricing. Figure 1 shows the case of zero profits emergent from a zero pricing strategy. From the graph, it is evident that ATC and MC are constant with each other. Although there are no numbers to ascertain what MC and ATC are at different quantities, it is evident that the two are consistent with each other and MR is twice as steep as demand, therefore, ATC is tangent to demand at an equal quantity (Q) where MC=MR. This graph shows the intercept of MR and demand where ATC and MC curves derive from the same TC curve at a certain quantity. Therefore, at such quantity (Q), profits realized will be zero (Phlips 1983, 152). Figure 2 In this graph, the variable cost per unit is similar despite the production level because despite the quantity of components bought, the price remains the same; $10 per unit. Therefore, if such a company produces more valves, it will have to purchase additional components, therefore, the total price and cost will increase. References Engelson, M 1995, Pricing strategy: An interdisciplinary approach, Joint Management Strategy, Oregon. Nagle, T, Hogan, J & Zale, J 2010, The strategy and tactics of pricing: A guide to growing more profitably, 5th edn, Prentice Hall, New York. Phlips, L 1983, The economics of price discrimination, Cambridge University Press, New York. Poundstone, W 2010, Priceless: The myth of fair value (and how to take advantage of it), Hill and Wang, London. Read More