Dynamic pricing

Abstract

This chapter reviews pricing issues that are relevant to oligopolistic firms competing in markets characterized by demand dynamics, i.e. state dependence and reference price effects. Normative models of dynamic pricing predict that (1) in inertial markets, competing firms have an incentive to compete fiercely using low prices in the early (growth) stages, but tacitly collude on high prices in the later (mature) stages, (2) variety-seeking markets always sustain higher prices for competing firms, and (3) markets with reference prices show cyclical pricing, which is more profitable for competing firms as long as enough consumers weigh price gains more heavily than price losses. Descriptive models of dynamic pricing show that (1) competing firms in inertial and variety-seeking markets indeed account for the future effects, in addition to current effects, of their current pricing decisions, and (2) such firms behave in a boundedly rational manner in the sense of looking into a few future periods only. Descriptive models of dynamic pricing in the presence of reference price effects need to be estimated in future research.