All business faces a similar question: What price for their product will generate the maximum profit? The answer. is not always obvious: Raising the price of something often has the effect of reducing sales as price sensitive consumers seek alternatives or simply do without. For every product, the extent of that sensitivity is different. The trick is to find the point for each where the ideal. tradeoff between profit margin and sales volume is achieved. Right now, the developers of a new private toll road between Leesburg and Washington Dulles. International Airport are trying to discern the magic point. The group originally projected that it could charge nearly $2 for the 14-mile one-way trip, while attracting 34,000 trips on an average day from overcrowded public roads such as nearby Rout 7. But. after spending $350 million to build their much heralded "Greenway", they discovered to their dismay that only about a third that number of commuters were willing to pay that much to shave 20 minutes off their daily commute...It was only when the company, in desperation, lowered the toll to $1 that it came quite. close to attracting the expected traffic flows. Clifford Winston of the Brookings Institution and John Calfee of the American Enterprise Institute have considered the toll road's dilemma...Last year, the economists conducted an elaborate market test with 1.170 people across the country who were each presented with a series of options in which they were, in effect, asked to make a personal tradeoff between less commuting time and higher tolls. In the end, they concluded that the people who placed the highest value on reducing their commuting time already had done so by finding public transportation, living closer to their work, or selecting jobs that allowed them to commute at off-peak hours. Conversely, those who commuted significant distances had a higher tolerance for traffic congestion and were willing to pay only 20 percent of their hourly pay to save an hour of their time. Overall, the Winston/Calfee findings help explain why the Greenway's original toll and volume projections were too high: By their reckoning, only commuters who earned at least $30 an hour (about $60,000 a year) would be willing to pay $2 to save 20 minutes. Suppose, indeed, that the demand for using the private road comes from two types of consumers: those for whom time is very precious and are willing to pay a lot for using the (private) road and saving some time, and those who do not mind to spend a little bit more time in the car and, hence, their demand. for using the (private) road is very elastic. Can your suggest a pricing strategy that will enable the firm to " identify the different drivers and charge them different prices, so that profits will be higher?

Understanding Business
12th Edition
ISBN:9781259929434
Author:William Nickels
Publisher:William Nickels
Chapter1: Taking Risks And Making Profits Within The Dynamic Business Environment
Section: Chapter Questions
Problem 1CE
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All business faces a similar question: What price for their
product will generate the maximum profit? The answer
is not always obvious: Raising the price of something
often has the effect of reducing sales as price-sensitive
consumers seek alternatives or simply do without. For
every product, the extent of that sensitivity is different.
The trick is to find the point for each where the ideal
tradeoff between profit margin and sales volume is
achieved. Right now, the developers of a new private
toll road between Leesburg and Washington Dulles
International Airport are trying to discern the magic
point. The group originally projected that it could
charge nearly $2 for the 14-mile one-way trip, while
attracting 34,000 trips on an average day from
overcrowded public roads such as nearby Rout 7. But
after spending $350 million to build their much
heralded "Greenway", they discovered to their dismay
that only about a third that number of commuters were
willing to pay that much to shave 20 minutes off their
daily commute...It was only when the company, in
desperation, lowered the toll to $1 that it came quite
close to attracting the expected traffic flows. Clifford
Winston of the Brookings Institution and John Calfee of
the American Enterprise Institute have considered the
toll road's dilemma... Last year, the economists
conducted an elaborate market test with 1.170 people
across the country who were each presented with a
series of options in which they were, in effect, asked to
make a personal tradeoff between less commuting time
and higher tolls. In the end, they concluded that the
people who placed the highest value on reducing their
commuting time already had done so by finding public
transportation, living closer to their work, or selecting
jobs that allowed them to commute at off-peak hours.
Conversely, those who commuted significant distances
had a higher tolerance for traffic congestion and were
willing to pay only 20 percent of their hourly pay to save
an hour of their time. Overall, the Winston/Calfee
findings help explain why the Greenway's original toll
and volume projections were too high: By their
reckoning, only commuters who earned at least $30 an
hour (about $60,000 a year) would be willing to pay $2
to save 20 minutes. Suppose, indeed, that the demand
for using the private road comes from two types of
consumers: those for whom time is very precious and
are willing to pay a lot for using the (private) road and
saving some time, and those who do not mind to spend
a little bit more time in the car and, hence, their demand
for using the (private) road is very elastic. Can you
suggest a pricing strategy that will enable the firm to "
identify the different drivers and charge them different
prices, so that profits will be higher?
Transcribed Image Text:All business faces a similar question: What price for their product will generate the maximum profit? The answer is not always obvious: Raising the price of something often has the effect of reducing sales as price-sensitive consumers seek alternatives or simply do without. For every product, the extent of that sensitivity is different. The trick is to find the point for each where the ideal tradeoff between profit margin and sales volume is achieved. Right now, the developers of a new private toll road between Leesburg and Washington Dulles International Airport are trying to discern the magic point. The group originally projected that it could charge nearly $2 for the 14-mile one-way trip, while attracting 34,000 trips on an average day from overcrowded public roads such as nearby Rout 7. But after spending $350 million to build their much heralded "Greenway", they discovered to their dismay that only about a third that number of commuters were willing to pay that much to shave 20 minutes off their daily commute...It was only when the company, in desperation, lowered the toll to $1 that it came quite close to attracting the expected traffic flows. Clifford Winston of the Brookings Institution and John Calfee of the American Enterprise Institute have considered the toll road's dilemma... Last year, the economists conducted an elaborate market test with 1.170 people across the country who were each presented with a series of options in which they were, in effect, asked to make a personal tradeoff between less commuting time and higher tolls. In the end, they concluded that the people who placed the highest value on reducing their commuting time already had done so by finding public transportation, living closer to their work, or selecting jobs that allowed them to commute at off-peak hours. Conversely, those who commuted significant distances had a higher tolerance for traffic congestion and were willing to pay only 20 percent of their hourly pay to save an hour of their time. Overall, the Winston/Calfee findings help explain why the Greenway's original toll and volume projections were too high: By their reckoning, only commuters who earned at least $30 an hour (about $60,000 a year) would be willing to pay $2 to save 20 minutes. Suppose, indeed, that the demand for using the private road comes from two types of consumers: those for whom time is very precious and are willing to pay a lot for using the (private) road and saving some time, and those who do not mind to spend a little bit more time in the car and, hence, their demand for using the (private) road is very elastic. Can you suggest a pricing strategy that will enable the firm to " identify the different drivers and charge them different prices, so that profits will be higher?
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