Willingness To Pay

Imagine a store, not just any store, one that sells just Aquafina brand of standard size bottled water.
Suppose there are no price lists, no price postings anywhere in the store.  You walk in to the store and pickup a bottle and walk to the cashier, who instead of scanning the barcode on the bottle scans your forehead. A LCD display flashes the price, $1.09. You pay that amount and enjoy the bottle of water.

It is you again and the same store, but a different day. You have just run 10K, practicing for Bolder Boulder race. As you walk to the cashier with the bottle, the LCD now reads $2.25.  You pay as indicated.

This scenario is  described as the Monopolist Dream, the Holy Grail of First Order Price Discrimination.  The price that flashes on the LCD display is your Willingness To Pay. The price is not only different for different customers, but is different to you as well based on your need.

Willingness to Pay is exactly that, how much you value the product. Priced exactly at your WTP, you are indifferent to keeping the money vs paying for it. Priced even a penny above you will not buy, and anything less you get a price rent or more commonly defined as "Consumer Surplus".

For the business owner, both situations are sub-optimal, they either let you walk out with too much surplus or lose out on sales. Every business would love to get the exact WTP of every customer who walks into their store.  But that is not possible, hence we need the multiple pricing models, customer segmentation and all the research that goes with it

Next time you walk into Chipotle, think why the Vegetarian Burrito is priced at $5.29? How much surplus are you getting at that price?

Source: My class notes from Microeconomics by Professor Steven Tadelis.