At a high level, Microsoft's entire digital business can be boiled down into one very simple formula, more or less described in every economics book ever made:

The “Number of Ads Delivered” is primarily driven by two factors:

1. The amount of engagement and number of active users on their platforms, found in Facebook’s filings. These figures are extremely predictable over time.

2. The number and frequency of ads served per view, which are completely under Facebook’s control.

These lead us to the “Price of Ads Delivered,” which includes a mixture of programmatic guaranteed (fixed) and real-time bidding (variable) pricing — both negotiated based on current rates. This is where it gets interesting…

Looking at Facebook’s public disclosures, they publish quarterly growth rates for “Number of Ads Delivered” and growth rates for “Average Price of Ads Delivered” from quarter to quarter. Adjusting for seasonality, we can see in the below table that the price demanded is extremely inelastic.

An inelastic demand (e<1) means Facebook receives outsized profits at higher prices and is heavily incentivized to encourage higher pricing.

So what does this mean for folks who haven’t read an economics book since college… basically two things:

1. Inelastic demand means that advertisers will not change the number of ads or impressions desired at the same rate as the price increase. Therefore, demand only slightly decreases when prices skyrocket. Examples of other inelastic markets include gasoline and cigarettes, where buyers really don’t (or can’t) change their purchasing decisions with price increases.

2. Facebook generates more revenue when either the number of ads served increases, or when the price increases.

The Bottom Line: Facebook is highly incentivized to encourage higher prices and higher demand.

But, there’s more…

Facebook prices experience incredible volatility as seen demonstrated by the 2 year price bands and 12 month look back diagrams below. The price volatility seen below are over twice that of the oil markets and over five times that of the US equity markets.

The volatility adds an important layer of complexity to the relationship. The constant price changes creates an information advantage for the players who will have a best idea for what a “fair” price is. Facebook, as the only seller, would of course have the best information which helps explain why so many advertisers choose to trust Facebook to choose the price.

See the the Complete Analysis on Facebook Stock Here