Welfare Analysis of Dynamic Pricing

Abstract

Dynamic pricing is designed to increase the revenues or profits of firms by adjusting prices in response to changes in the marginal value of capacity. We examine the impact of dynamic pricing on social welfare and consumers’ surplus. We present a dynamic pricing formulation designed to maximize welfare and show that the welfare-maximizing dynamic pricing policy has the same structural properties as the revenue-maximizing policy. For systems with scarce capacity, we show that the revenue-maximizing dynamic pricing policy and the market-clearing price are both asymptotically optimal for welfare. We also find in most cases that revenue-maximizing dynamic pricing improves consumers’ surplus compared to the revenue-maximizing static price. Our findings can potentially transform the public image of dynamic pricing and provide new managerial insights as well as policy implications: (1) in large-scale systems with scarce capacity, a central planner would essentially implement the same pricing policy as a firm with monopoly power; (2) the revenue-maximizing dynamic pricing policy can benefit customers when the demand elasticity is in a small bounded interval as is the case for several important demand functions. The online appendix is available at https://doi.org/10.1287/mnsc.2017.2943 . This paper was accepted by Serguei Netessine, operations management.

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