Countercyclical Pricing in Customer Markets

Abstract

I present a dynamic model of price determination in customer markets that are subject to exogenous business cycle fluctuations. The business cycle is described in terms of a Markov process, in which market demand alternates stochastically between fast growth (boom) and slow growth (recession) phases. In the consumers' preferred equilibrium outcome, ( 1 ) prices are below the monopoly level, and ( 2 ) prices are countercyclical when demand growth rates are positively correlated through time. A firm faces a dynamic trade‐off when making its current price selection. While a higher price may raise a firm's profit in the short term, it also may diminish the firm's reputation for low prices, leading to lower profits in the future.

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