So I, like many of you, have received an email today offering £10 off a £20 spend on goods offered through selected sellers on eBay.
The terms and conditions attached to the offer were that it had to be used through a PayPal seller and on a good with a price over £20.
I’d like to take a moment to assess eBay’s rationale for promoting this offer. A simple demand and supply analysis would show that the offer effectively increases the reservation price of each consumer purchasing eBay’s products. This would mirror an increase in demand that would have to be rationed against a fixed supply. Prices would increase – but pretty much only back to the level for buyers that they were effectively before (sans the £10 discount). Of course eBay wouldn’t actually break even in this scenario as sellers must take their cut of the increase in price and therefore there must be another mechanism involved.
Take a note of the diagram below:
In my opinion this is a more accurate representation of the market for the products sold on eBay. From a knowledge of eBay virtually since it’s inception it’s been apparent to me that goods tend to have a ‘latent price’ – a price that most goods sit at for the majority of their auction period. At the start of the auction bidders bump up the price – viewing unreasonably low prices as ‘gambles’ that others might miss. The auction then sits at the ‘latent price’ until the final few minutes, in many cases, when interested buyers reveal their reservation prices and the highest wins.
I’ve marked the latent price on the above diagram as P*. The logic of the latent price is that it becomes the separator between participants and non-participants. Consumers with reservation prices below P* will not even watch the auction as the good is already too expensive for their valuation. Such consumers lie on the DN demand curve of the diagram. Those with reservations above P* participate in the auction and reveal their reservation prices at the end.
The caveat? Consumers who participate, in theory, induce an increase in their reservation price through the fear of losing out on the product (and the negative utility that comes with it). Thus at the P* divide the demand curve jumps outwards as consumers are willing to spend more to win the auction.
This caveat provides the incentive for eBay to promote the £10 offer. Just take a look at the diagram below.
Initially the market shows an equilibrium at price P’ as consumers value the products on eBay at a lower price than is needed for mass participation – highlighting the need for eBay to promote the offer. Through the offer both demand curves, DN1 and DE1, shift respectively to DN2 and DE2. This shift pushes the equilibrium over the participation line at P* and so not only are more consumers demanding the product – increasing the price – but their reservation prices are even higher due to participation. This skyrockets the price to Pdot – potentially enough for eBay to profit from their investment.
Although I’ve not marked it explicitly on the diagram do note the large increase in output along with the rise in price – contributing further to eBay’s revenue through extra insertion and sales fees.
Those who choose to take advantage of the offer for eBay would be wise to watch out for inflated prices over the next couple of days and should be careful not to be sucked into the experiential heightening of valuations.