Willingness to pay is a reflection of the maximum amount a consumer thinks a product or service is worth. It is considered when developing an asking price for products and services, although it is important to note that it is not the final arbiter of pricing. In addition to being involved in the pricing process, it is also considered when conducting larger studies about how consumers interact with products and services.
For individual consumers, willingness to pay can vary, depending on their personal assessment of the value of a product or service. Surveys conducted by colleges and universities have shown, for example, that willingness goes up when people are looking at well-respected and well-known colleges and universities, and it goes down for smaller and less famous institutions. Families that value education generally put a higher value on it, while families that have not sent many members to college may value a college education at a lower number. It can also be heavily linked with branding, with people being willing to pay more for comparable brand name products.
When pricing products, companies want to hit a price point that most people are willing to pay that also allows the company to generate a profit. Sometimes, people may place the value of a product below the value of production, leaving the company with a problem. If the product is priced at the point people will pay, the company will take a loss, but if it is priced more reasonably, the company may not make as many sales.
This concept also plays into studies such as cost-benefit analyses and efficiency studies. People involved in such studies are usually tested with choice experiments. In these experiments, individuals are confronted with an array of items to choose from, and are asked a series of questions about the cost of these items. Choice modeling of this nature is also used for developing pricing strategies and for exploring how people respond to different prices; prices ending in $0.95, for example, tend to be viewed as more acceptable than prices ending in random numbers like $0.43.
Within a larger economic context, looking at how people interact with prices can become very important. Understanding how consumers make buying choices on the basis of price, especially for luxury goods, is an important part of studying how consumers make choices in general. Willingness to pay studies can be applied to everything from health care systems to sales of groceries.