by Tim Langeman

One of the most important concepts that MFTransparency addresses in all of our trainings and educational materials is the relationship between interest rates and loan size in microfinance, which we represent with a curve. This curve is even depicted as part of our logo. Throughout this web site, there are a series of graphs that plot this relationship using real data.  In many cases, the graph trend line follows a curve in which the smaller-sized loans carry higher interest rates than larger-sized loans.  As the loan size increases, interest rates tend to decrease.

Several posts on this blog have addressed the price curve in microfinance. In this post I will consider the relationship between price and quantity in other industries. What accounts for the curve, and is this type of curve present in industries other than microfinance?

As an experiment, I decided to visit a local grocery store and look for items that are sold in multiple package sizes. Two good examples are soft drinks and ice cream.

The grocery store that I visited also has a very convenient “unit price” printed beside the total price.  The unit price performs the same role as the interest rate, making it possible to compare different sized packages, just as an interest rate allows the comparison of different sized loans.

Here is the data for ice cream:

Notice that the unit price decreases as the package size increases.

Note: Ice cream in the US is sold in a mix of units, including ounces, pints, quarts, and liters. All unit prices are calculated using the common unit of "fluid ounce" (FL OZ).

Soft drinks follow a similar trend, but are more complicated, due to a wider variety of packaging options. (see spreadsheet below for more information)

From the graph above you can see that if you want to buy a smaller quantity of ice cream you will pay more per unit for that ice cream, much like the way that microfinance clients who need smaller loans often pay higher prices for them. In microfinance this is because the cost of offering a loan is relatively flat, so the price needed to cover that cost is higher as a percentage of the loan amount the smaller the size of the loan. Presumably there is a similar factor at work for the price of ice cream. If the costs of producing and selling ice cream are fairly flat relative to the quantity of ice cream, then the price per unit gets smaller as the quantity produced increases.

I suspect that if we did an exhaustive survey of every product in the grocery store, we would find some products that follow a steeper curve and other curves that are shallower.  What factors do you think influence these pricing structures?  Here are a few differences that might explain price variation:

• Packaging costs
• Consumer demand for different sizes
• Market competition

How do these differences relate to the price curve in microfinance? What factors influence the steepness of the price curve for microloans?

Now that you are aware of a price curve in ice cream, can you see examples of price curves for other products that you purchase?  Is this concept equally relevant in different industries, countries, and cultures?

Although in many ways microfinance is a unique industry, it still operates under many of the same market forces as any other industry. If you don’t know a lot about microfinance, you may not need to go any further than the grocery store to learn something about it!

Download Data for this Post in Excel

Last 3 posts by timlangeman

• Calculating Effective Interest Rates Using Cashflow Discounting - October 26th, 2010
• The Devil is in the Dates - October 6th, 2010
• Calculating Interest Rates Using Newton’s Method - March 5th, 2010

Tags: Price Curve, Pricing

This entry was posted on Saturday, August 7th, 2010 at 3:30 pm and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.