Willingness to pay

Let's start off with a very simple example for a typical consumer decision. This will show you the principle of the "willingness to pay", which is part of the basics for economics.

A consumers decision:

Example 1:
Its a rainy day and a friend of yours invited you to go to the cinema with him. The ticket costs exactly 10$.

Question: Should you go to the cinema?

Well we cant answer that question just yet. In order to do that, we need to know what your alternative for that day would be. So our question is never "Should I do this?" but rather "Should i do this or that?"

Now the easiest alternative to going to the cinema would be to stay at home and do nothing. But we still can't answer that question if we don't know how high is your personal gain from going to the cinema (or staying at home).

Thats where our first keypoint in economics comes in:

Willingness to pay:

Lets say you would be willing to pay 20$ to go to the cinema (because you are going to watch the "Dark Knight Rises" and that movie is freaking awesome). That means if the ticket would actually cost 20$ you would be indifferent. This means:

• If the ticket costs more than 20$ you would stay at home
• If the ticket costs less than 20$ you would go on an epic adventure with Batman

So lets give this idea some kind of a formula:

• WPA is the willingness  to pay for the ticket (20$)
• GA is the personal gain for going to the cinema and CA  is the cost for the ticket
• GB is the personal gain from staying at home and CB the correspondent costs (GB = 0 and CB = 0) 

This means you will go to the cinema if GA - CA > GB - CB and you would stay at home if GA - CA < GB - CB. You would be indifferent in case if GA - CA = GB - CB.

This means your willingness to pay is:

WPA = GA - GB + CB

 

So if your best alternative would be to stay at home, you should go to the cinema as long as the ticket costs less than 20$. But what if there is a better alternative than staying at home? Now I will show you an alternative with different costs/benefits.

Example 1:
If you don't go to the cinema, you could go eat some ice cream.

• One ice cream costs exactly 1$ so the Ci = 1$
• You would be willing to pay about WPi = 10$ for eating ice cream, rather than staying at home doing nothing at all
• This means your personal gain from eating ice cream is Gi = WPi = 10$
• So you will go to the cinema as long as GA - CA > Gi - Ci
• Since 20 - 10 > 10 - 1 you should go to the cinema