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Skimming pricing for a class of diffusion models
Author(s) -
Rao Ram C.
Publication year - 1986
Publication title -
optimal control applications and methods
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.458
H-Index - 44
eISSN - 1099-1514
pISSN - 0143-2087
DOI - 10.1002/oca.4660070210
Subject(s) - economics , demand curve , price elasticity of demand , microeconomics , order (exchange) , diffusion , econometrics , dynamic pricing , market demand schedule , product (mathematics) , mathematics , physics , geometry , finance , thermodynamics
This paper examines the optimal dynamic pricing policy of a monopolist faced with demand that follows a first‐order adjustment process. This adjustment process is assumed to capture the diffusion of a new durable good. Under these conditions the optimal policy has the structure of skimming, i.e. high initial prices followed by monotonically declining prices. This corresponds to the usual notion of a price discriminating monopolist who travels down the demand curve in order to garner all consumer surplus, but with one difference. Specifically, it is seen that when cash flows are not discounted the policy is to travel down a line that is parallel to the demand curve if demand is linear in price. If demand is of the constant elasticity type, the policy is to travel down a curve that is steeper than the demand curve. Finally, when profits are discounted, initial prices are lower than in the undiscounted case, thus increasing the rate of product diffusion initially.