The reservation price is the price that a consumer is just about willing to pay for a certain good. This marks the upper limit of his willingness to pay and is an important indicator for companies with regard to pricing and pricing.
In this lesson we explain the reservation price and how it relates to the consumer surplus. You can then check your knowledge with a few exercise questions.
- Synonyms: reservation price
- English: Reserve price | reservation
Why should you know the reserve price?
For companies, the reservation price represents the upper limit for pricing a specific product. It is therefore important to know this price and the associated consumer surplus. As a result, entrepreneurs know at what price they can offer a product and when they can expect a drop in sales.
Information content of the reservation price
From the customer’s point of view, the reservation price describes the maximum price that a consumer is willing to pay for a certain good. If the price of the product is higher, the result is lower sales. From the entrepreneur’s point of view, it is the lowest possible price at which he is willing to offer a product.
How high the reservation price actually turns out on the customer side depends on both the income and the preferences of the consumers:
High-income consumers will pay more for a particular product if they value it accordingly. As the price increases, the number of customers decreases until it finally reaches zero.
From the point of view of the entrepreneur, the reservation price is derived from internal company calculations. Here, for example, input factors such as raw materials, development costs and marketing expenses play a role. The reservation price is the price that the entrepreneur would just accept for another unit of the same product.
Reservation price in the supply and demand function
A software developer wants to develop accounting software for retail and calculates that the product must cost at least € 800 for the development to be worthwhile. This is also the reservation price from the developer’s point of view.
Thanks to good market knowledge, the company knows that the retailer’s reservation price is on average € 1,000, which corresponds to the reservation price from the customer’s point of view. It can therefore set the price of the software between € 800 and € 1,000.
Reserved price in the price response function
According to foodanddrinkjournal.com, the manufacturer’s reservation price runs along the supply curve and increases with increasing supply to grow. The customer’s reservation price, on the other hand, runs along the demand function. The intersection of the two functions represents the market equilibrium. Both reservation prices are the same here.
If the sales price is below the customer’s reservation price, these customers benefit from what is known as consumer surplus. It is formed from the difference between the reservation price and the price actually paid. The manufacturer should always try to differentiate the prices as well as possible and thus demand the price from each customer that corresponds to his reservation price without falling below his own reserve price.
Example of price differentiation
The software developer mentioned above has decided to offer his product for € 900. But he also wants to reach those customers whose reservation price is between € 850 and € 900. For this purpose, he offers a version with a lower range of functions, the price of which he can set in precisely this area.