ECC3841 Chap.10 Pricing and Word-of-Mouth
Pricing and Word-of-Mouth
Network pricing adds awareness to the firms demand problem. A lower price can raise direct purchases and encourage buyers to communicate, creating new informed demand. Consumers differ in valuation and number of contacts, and those dimensions may be correlated. Advertising value depends on purchase probability, unique new reach and later diffusion.
Degree overstates a targets value when neighbors overlap or are already informed.
What this chapter covers
- 01
Initially unaware consumers
- 02
Valuation and purchase choice
- 03
Degree distributions
- 04
Price and communication incentives
- 05
Direct and diffusion demand
- 06
Advertising reach
- 07
Targeting with overlap
- 08
Incremental profit and network externalities
Worked example · free
Compare two advertising targets
- +1A creates expected value 0.8 times four, equal to 3.2.
- +1B creates expected value 0.5 times seven, equal to 3.5.
- +1B leads before overlap and later-round effects.
- +1Check whether contacts are unique and unaware.
- +1Subtract advertising cost before the profit conclusion.
Key terms
- Word-of-mouth
- Consumer-to-consumer communication that changes product awareness or demand.
- Diffusion demand
- Additional demand created when buyers transmit product information through the network.
- Degree distribution
- The population distribution of numbers of contacts.
- Target overlap
- Redundancy created when candidate targets reach the same people.
- Marginal reach
- The number of newly informed people produced by an additional target.
- Awareness margin
- The change in demand created when consumers learn that a product exists. It is distinct from the conversion margin among people who were already informed before price or advertising changed.
- Conversion probability
- The chance an informed target purchases and activates the assumed communication channel. High degree has limited campaign value when the target is unlikely to convert or transmit.
- Target redundancy
- The overlap in people reached by multiple advertised consumers. Redundancy makes joint campaign value smaller than the sum of each targets value calculated in isolation.
- Diffusion incentive
- The firms reason to alter price or advertising because current purchases generate future awareness. Its strength depends on communication response, network structure and the value of newly informed demand.
- Dynamic pricing
- A sequence of prices that can change as awareness and purchasing evolve. It differs from a committed posted price because consumers may anticipate future discounts and delay purchase.
- Incremental profit
- The change in revenue minus cost caused by a pricing or targeting action. It counts lost margin on existing sales, added direct and diffusion demand, overlap and campaign expenditure.
- Fully informed demand
- Demand when every potential consumer already knows the product exists. It is the benchmark that removes the awareness margin and isolates ordinary willingness to pay.
- Campaign sequence
- The order in which targets receive advertising. Because earlier targets inform some neighbors, every later targets marginal reach must be recomputed against the awareness already created.
- Conversion margin
- The change in purchases among consumers who already know the product exists. It must be separated from newly aware demand so a price or advertising response is not counted twice in incremental profit.
- Awareness stock
- The set or share of consumers who know the product exists at a particular time. Pricing and advertising change future demand partly by changing this stock through communication.
Pricing and Word-of-Mouth FAQ
Why can a lower price increase awareness?
More informed consumers may buy and communicate, spreading product information to friends and expanding the informed market. Compare incremental profit after conversion, unique reach, overlap, margin loss and campaign cost are all counted.
Should the firm target the highest-degree consumer?
Only if those contacts are likely to be newly informed and the target is likely to buy and communicate. Overlap can erase raw-degree advantages. Compare incremental profit after conversion, unique reach, overlap, margin loss and campaign cost are all counted.
How do valuation and degree interact?
High-degree consumers may have systematically different willingness to pay. Targeting and pricing results depend on whether those traits are independent or correlated. Compare incremental profit after conversion, unique reach, overlap, margin loss and campaign cost are all counted.
What is the final decision criterion?
Compare incremental profit, including lost margin, added direct and diffusion demand, advertising cost and overlap. Reach alone is not the objective. Compare incremental profit after conversion, unique reach, overlap, margin loss and campaign cost are all counted.
Exam move
Draw the sequence from awareness to purchase to communication to new awareness before writing profit. Consumers who never learn the product exists cannot appear on the ordinary demand curve, so label the awareness margin separately from conversion conditional on awareness. A price cut can raise direct purchases among informed consumers and stimulate communication that creates newly informed demand.
Count each buyer once when the channels overlap. Write the fully informed monopoly benchmark, then add the diffusion response and identify which derivative changes. Do not claim networks always lower price; the result depends on cost, communication responsiveness, valuation and degree. State whether valuation and number of contacts are independent.
Correlation changes both conversion and reach, so an independence result cannot be transferred without checking. For advertising, calculate a targets purchase probability times direct value plus unique newly informed neighbor value, then subtract campaign cost. Replace degree with marginal reach after accounting for already informed contacts and overlap with earlier targets.
Recompute a sequential campaign after every selected seed. If later rounds matter, state the propagation rule rather than quietly treating first-round reach as the full cascade. Compare high-degree, bridge and trusted targets under the mechanism. A bridge may create novel reach, while a trusted moderate-degree consumer may convert and communicate more reliably.
Price and advertising may be complements when a lower price makes advertised targets more likely to activate word-of-mouth, or substitutes when broad advertising removes the need to use price for awareness. Treat the relationship as a model conclusion. Timing matters: a one-time committed price differs from dynamic pricing as awareness grows, and expected discounts can make buyers wait.
Keep information diffusion separate from consumption externalities, where friends purchases change utility directly. For revision, solve one expected-target calculation, one overlap adjustment and one incremental-profit comparison. Print baseline sales, lost margin, added direct demand, added diffusion demand and advertising cost on separate lines. Then add consumer surplus if welfare is asked.
Finish by explaining who becomes newly informed and whether targeting widens unequal information access. The decision criterion is incremental profit or stated welfare, never follower count alone.
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