Monopolist Pricing with Dynamic Demand and Production Cost

Abstract

This paper deals with pricing of a new product over time by a monopolist who maximizes the discounted profit stream. The interdependency of cost and demand on cumulative production makes the problem inherently dynamic. Cost is assumed to be declining with cumulative production (learning curve effect), while demand is a function of price and cumulative sales, representing word-of-mouth and saturation effects. The paper addresses this problem in a general framework that includes several previous results as special cases, and provides new insights in other situations. While the learning curve and word-of-mouth effect cause prices to be lower than the price that maximizes immediate revenues, the saturation factor has the opposite effect. The price path over time is affected by these factors and the interest rate. We characterize the price path under several different situations and interpret the results for policy guidelines.

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