Some readers will already have this as assumed background, but I think many will benefit from reviewing the econ-101 (non-behavioral) story of bundling, which explores its economic effects on rational actors with no frictions to search or decision-making. I explain these briefly in (Naïve) microeconomics of bundling goods (just posted).
Excerpt from the conclusion:
Both the seller of sandwiches and the song store wish they could apply price discrimination and sell each good at 1% below what the buyer would be willing to pay. Unfortunately for them, they can’t. As a result, they end up picking a compromise price that gets about half the potential profits by selling at an average-ish price to about half the people. (It’s a coincidence that the seller-maximizing price is the average of the profitable customers’ valuations, by the way—if you try other distributions this doesn’t happen.)
What the song store can do (that the sandwich-seller can’t) is exchange the market for songs—which has high variance in customer valuations—for the market for song bundles, which has much lower variance because of the law of large numbers. Then, when the customers’ valuations all cluster around the average of $550 per library = $0.055 per song, the seller can price just below that and sell to nearly everyone at around the average price. This is better for the seller than pricing each individual good at an average-ish price and selling to half the people.
Some readers will already have this as assumed background, but I think many will benefit from reviewing the econ-101 (non-behavioral) story of bundling, which explores its economic effects on rational actors with no frictions to search or decision-making. I explain these briefly in (Naïve) microeconomics of bundling goods (just posted).
Excerpt from the conclusion: