Open Bar to Capture Consumer Surplus

5 February 2017
5 Feb 2017
3 min read

When studying microeconomics, a typical question for a monoploy proceeds as follows: What is the best way to capture all the consumer surplus?1

Consumer Surplus

The trick to capturing this surplus can be done in a couple of ways. Ideally, as a producer I could know what each person was willing to pay as soon as they walked in to my store. That way, all I had to do was to set the price of my good equal to that amount, and take all of the consumer surplus as profits.

However, that isn’t possible for a variety of reasons (yet). By being forced to set the same price for each customer, there’s an inefficiency that exists. Customer 1 may be willing to pay 100 dollars, but customer 2 may only be willing to pay 80. By setting my price as 80, I end up with more profits than if I set the price to be 1002, yet I’m still leaving money on the table for customer 1. The best we can do maximize profits is to approximate, and different methods of price discrimination exist to help solve that problem.

One method of approximation is to set the cost of one unit equal to it’s marginal cost, and then take out the consumer surplus through some other sort of fee. Continuing with the above example, I can set the price equal to its marginal cost (say 20) and then force consumers to pay off the total consumer surplus. This can be done either by bundling, where the bundle is priced at the amount of the consumer surplus, or more commonly is through some sort of up front fee. In the vein of Costco and Sam’s Club, this technique is popular among wholesalers. In a real life example, we can take Costco. In a Costco, the goods are priced at marginal cost, but there is an entrance fee in the form of a membership to access these cheaper goods.

Another example that struck me was an Open Bar. If we take the cost of the alcohol as fixed3 as well as noting that the supply of labor is fixed for that night4, then the marginal cost of an alcoholic beverage is zero. By selling the option of an Open Bar, the bar is attempting to capture all of the relevant consumer surplus ahead of time as opposed to taking it out piecemeal, drink by drink. The cost of the Open Bar most likely outweighs what one would have spent on alcohol to begin with; the bar ends up walking away with more money then it would have received otherwise.5

It’s always fascinating to see pricing techniques being practiced outside of the classroom. The effectiveness of these techniques can be seen simply by how far they spread and how popular they become.

  1. Consumer surplus is defined as the area above the cost curve and below the demand curve, or what consumers are willing to pay. See the graph below for an example. ↩︎

  2. By selling to customer 1, I make 100. By selling to both customers for 80, I receive 160 in profits. ↩︎

  3. Imagine a contract where the alcohol is ordered weeks in advance. ↩︎

  4. I can’t hire another bartender the night of an event ↩︎

  5. I can imagine all you can eat sushi and buffets function in a similar fashion. ↩︎

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