Individual Assigment 2: Lift 1.6667

Vui Ta
Management 107
Student ID:36615738

INDIVIDUAL ASSIGMENT 2
Q1. (10 pts): Below is a table of average sale information that a local small
grocery store has collected from 4pm to 6pm on every Friday.
a) Use Market Basket Analysis (Support, Confidence, and Lift) to compare

two cases.
By the definition, support is the probability that two items will be purchased
together – P(A&B); confidence is the conditional probability estimate – P (A|B),
and lift is the ratio of the confidence to the base probability of buying an item – P
(A|B) / P (A). Applying those definitions to 2 cases:
Case 1: Consumer who bought potato chips also bought milk
- Support: the probability of purchasing.
P (potato chips & milk) = 3/50 = 0.06
- Confidence: the probability of buying milk given that person has bought
potato chips.
P (milk | potato chips) = 3/10 = 0.3
- Lift: the ratio of the confidence to the base probability of buying an item.
First, probability of buying milk: P (milk) = 9/50 = 0.18
è Lift = P (milk | potato chips) / P (milk) = 0.3/0.18 = 1.6667.
Case 2: Consumer who bought soda also bought milk
Similarly,
- Support: P (soda & milk) = 1/50 = 0.02
- Confidence: P (milk | soda) = 1/12 = 0.083
- Lift: P (milk | soda)/ P (milk) = 0.083/0.18 = 0.4629
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b) What does the result in a) imply? Please interpret the results in a).
There are three applications in the result of part a by using market-basket
analysis which are support, confidence, and lift showing the products that
customers tend to buy together between two cases.
First, in the market terminology, support is the probability that two items
will be purchased together. To estimate that probability, this small grocery store
should examine sales transactions and count the numbers of times that two items
occurred in the same transaction. From the data given by the question, potato chips
and milk appeared together 3 times, and thus the probability of potato chips being
bought together with milk is 3/50, or 0.06 (6%). Similarly, the probability of soda
being purchased together with milk are purchased together is 1/50, or 0.02 (2%).
Second, such a conditional probability estimate is called the confidence.
Given that a customer bought milk, we can estimate the probability she or he will
buy potato chips to be 3/10 = 0.3 (3%). and the likelihood of someone buying
soda, the estimate of probability, is 1/12 = 0.083 (8.3%).
Third, the ratio of confidence to the base probability of buying an item is
called lift. Lift shows how much the base probability increase or decrease when
other products are purchased. Applying this in to problem, the likelihood that the
consumers buy milk when they buy potato chips increases by 0.3/0.18 or 1.667
(66.7%). Also, similarly, the likelihood that people buy milk when they buy soda
decreases by 0.083/0.18 or 53.71%.
c) Based on the results in a), suggest a strategy which the store owner could
implement to increase sales of milk.
From the data and analysis provided in part A and part B, we can see that the
sales of milk improve alongside the sales of potato chips. Therefore, one of the
best strategies, which the store owner could implement to increase sales of milk, is
placing these two products on adjacent shelves in the hotspots such as main aisle or
in front of store, or by putting these two close by each other. Another strategy that
store owner could utilize and implement would be to promote milk and potato
chips as a bundle, or creating deals such as giving a discount on these two items to
incentivize customers to buy them together.
Q2. (10 pts) You are selling a software product called “Link” which is
available in high and low quality versions called Link Professional and Link
Home respectively. You have 2 units of Link Professional and 2 units of Link
Home. There are 2 potential customers, each of whom is interested in buying 1
unit of Link (either Link Professional or Home but not both). Suppose that
your objective is to maximize the total revenue from selling the software.
Further, you do not know the identity of either buyer and you must sell by
posting one price for Link Professional and another price for Link Home.
Each buyer seeks to maximize her consumer surplus and may buy Link
Professional or Link Home or neither depending on the prices that you post.
Please show all intermediate steps and clearly explain your reasoning.
i. What is the optimal price and resulting revenue under the following
scenario? What (if anything) would each customer buy?
A consumer’s willingness to pay (WTP) is equal to the maximum price the
firm can charge to the consumer. Therefore, starting to calculate consumer surplus
from the highest willingness to pay to the lowest willingness to pay then the firm
can find the most profitable price combination.
Letting price of Link Professional(LP) is Pp and price of Link Home((LH) is
Ph, and there are four different cases which are (600, 400), (600, 300), (500, 400),
(500, 300) to consider because there are 2*2 WTP in given question.
v Case 1: Pp = 600 and Ph = 400, each price is the highest willingness to pay
for each version,
- Buyer A’s consumer surplus from Link Professional = WTP of buyer A’s to
LP – Price of Pp = 600 – 600 = 0.
- Buyer B’s consumer surplus from LP = 500 – 600 = -100.
- Buyer A’s consumer surplus from LH = WTP of buyer A to LH – Price of
Ph = 400 - 400 = 0.
- Buyer’s B consumer surplus from LH = 300 – 400 = -100.
ð Based on the calculation above, if the firm prices at Pp=600 and Ph= 400,
Buyer B will buy neither Link Professional nor Link Home since consumer
surplus is negative; as the result this is out of question. However, for Buyer
A, Link Professional and Link Home are the same which is 0. Therefore, the
firm should sell Link Professional with $600 for profit maximization.
v Case 2: Pp = 600 and Ph = 300, similarly:
- Buyer A’s consumer surplus from LP = 600 – 600 = 0.
- Buyer B’s consumer surplus from LP = 500 – 600 = -100.
- Buyer A’s consumer surplus from LH = 400 – 300 = 100.
- Buyer B’s consumer surplus = from LH = 300 – 300 = 0.
ð In this case, buyer A and buyer B will want to buy Link Home because it
gives more consumer surplus that Link Professional. Therefore, the firm can
sell Link Home to both buyers with price $300, then the total profit is
300+300 = $600.
v Case 3: Pp = 500, Ph = 400
- Buyer B’s consumer surplus from LP = 500 – 500 = 0.
- Buyer A’s consumer surplus from HL = 400 – 400 = 0.
- Buyer B’s consumer surplus from HL = 300 – 400 = -100.
ð Buyer A and buyer B will prefer buying Link Professional since both
consumer surplus of LP > HL. Thus, the firm should sell Link Professional
to both buyer A and buyer B and making 2*$500 = $1000, which is the total
profit.
v Case 4: Pp = 500, Ph = 300,
- Buyer B’s consumer surplus from LP = 500 – 500 = 0.
- Buyer A’s consumer surplus from LH = 400 – 300 = 100.
- Buyer B consumer surplus from LH = 300 – 300 = 0.
ð Both buyer A and B consider Link Professional and Link Home are the same
products, so the firm should sell Link Professional to both buyers. Thus,
total profit is $500*2 = $1000.
Overall, Link Professional price should be kept at $500, and Link Home price
should keep as anything above $400. This will allow the firm to maximize the
profit to $1000, as both buyer A and buyer B are willing to buy Link Professional
at $500.
ii. If you could identify each buyer and make targeted offers, what price
would you offer to each and how much revenue would you earn? What (if
anything) would each customer buy?
To buyer A, the firm would offer Link Professional with the price of $600
and Link Home with price greater than 400, and to buyer B, the firm would offer
Link Professional with the price of 500 and Link Home with price greater than
300. The firm offers at a price above their WTP because they want buyers
purchasing Link Professional which would yield the firm more revenue. By doing
so, the firm could acquire the revenue of 600+500 = $1100.
Q3. (10 pts) Read part of 2013 Macworld article about App store below to
answer the following questions:
a. Does App store provide a two-sided platform.? If yes, are there same
side and cross side network effects? Please explain.
Yes, this App store does provide a two-sided platform in the app which is
between the developers and the users receiving benefits for each other. In other
words, one side deals with the app programmers opening their storefronts, and the
other side deals with the users who download the app based on their preferences.
While the users use and buy the app, and as the more users use and buy the app,
the more valuable it is. The developers create the app and get paid by the number
of users using it. Therefore, the users and the developers share the same economic
benefit from this relationship, this two-sided platform.
There are same side as well as cross side network effects in this case. This is a
cross side network effect because the users and the app developers need each other
to survive in this market. In particular, the app increases in value as there are more
users downloading it, so the app is dependent on the amount and number of users.
The programmer also needs more users to make profit and provide funding to the
company as well as for any further research and development of the app.
Therefore, this relationship works strong and positive in both directions and is
dependent on each other to increase the value of the app.
Beside the cross side network effect, there is same side network effect as well
because there is a competition among the developers to deliver the best app to the
consumers as the result of creating the same side network effect. Hence, for
developers, the same side effect is negative and weak. The same side network
effects also applied between the consumers as well because when one uses the app
if it is good user will have a good feedback to the app as the result of increasing the
number of users using the app. Reversely, if consumers are not interested the user
they will have a negative feedback, and this makes the app being less valuable to
the users. Thus, the same side effect for users is positive, but it can be strong or
weak.
b. Does App store operate in a market that exhibits “winner take all”
dynamics?
Yes, the App store operates in a market that exhibits “winner take all” dynamics
since it is qualified following the three conditions such as multi-homing cost,
network effects and user preference’s reactions. First, it is high in multiple homing
costs. Second, it exhibits the cross network effects are strong and positive. Last,
but not least, the consumers have undifferentiated preferences for this
service/product. There is fairly high homing cost for the consumers because they
will need to pay money to obtain and use the app. It also will increase high cost to
develop the apps for multiple platforms, and it would be expensive as well for
users to purchase multiple platforms for the apps. Network effects are strong and
positive because the users and developers rely on each other. The developers need
to make their apps appeal to the users, and the users are in need of a variety of apps
to choose from. There are also no strong preferences as each app made is the same
for every user who purchased it. The app does not change for every user. In
conclusion, “winner take all” dynamics are applied when a company produces
disruptive technology that creates a new market as well as the demand without any
competition. Apple has also done the same which has acquired the largest chunk of
the market share. Thus, Apple is taking all the revenue in that market segment
unless other competitors enter to the market.
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Vui Ta

a) Use Market Basket Analysis (Support, Confidence, and Lift) to compare

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