Long-Run Returns to Scale

88 Part II: Considering Which Side You’re On in the Decision-Making Process

Figure 5-7:

Examining the benefit of gift cards.

Issuing coupons

As with gift cards, businesses use coupons to bias customers toward buying a particular good or from a specific business. By giving customers a discount, you effectively lower the product’s price. An added advantage of coupons is that they allow you to differentiate between consumers with different price elasticities of demand — more on that in Chapter 13.

Back to your pizza restaurant (and you didn’t even know you owned one). Instead of the buy one, get one free promotion you did earlier in this chapter, you decide to run a special — $0.25 off each pizza slice with coupon.

Before the coupon, your customers were deciding between tacos priced at $0.50 each and pizza priced at $1.00 per slice. The customer had $3.00 to spend. The budget constraint for this situation is described by B a in Figure 5-8. In this situation, the customer maximizes utility by purchasing four tacos and one slice of pizza — the point where the indifference curve U a is tangent to the budget constraint B a .

If you now offer $0.25 off per slice of pizza, the effective price is $0.75 per slice. Now the customer can buy up to four slices of pizza. The new budget constraint is Bb in Figure 5-8. The pivot in the budget constraint reflects the lower after-coupon price of a pizza slice. As a result, the customer now purchases three tacos and two slices of pizza — the point where the indifference curve Ub is tangent to the new budget constraint Bb.