Dynamic Pricing and Price Commitment of New Experience Goods

Abstract

This paper develops a dynamic model to examine how a firm selling new non-durable experience goods can signal its high quality with dynamic spot-pricing or price commitment. Since consumers who buy and use the product will learn its quality, the firm’s early-period price will endogenously determine the number of informed consumers in the later period. Without price commitment, the high-quality firm prefers the pooling outcome in the first period, generating enough informed consumers to induce a separating equilibrium outcome in the second period where both types of firms serve only their respective first-period buyers. By contrast, if firms can commit to future prices, the high-quality firm can signal its quality by committing to an increasing price-path, either a lower-than-first-best price for the early period with a first-best price for the later period or the first-best early-period price with a higher-than-first-best future price. Price commitment will benefit the high-quality firm by lowering its signaling cost and hurt the low-quality firm by increasing its cost of mimicking the high-quality firm. Interestingly, the firm’s price commitment can either increase or decrease consumer surplus and social welfare. We show that a longer time horizon can allow the high-quality firm to costlessly signal its quality by maintaining its high first-best price for all periods. Our results are robust even when social learning (e.g., through consumer reviews) is considered.

Keywords: signaling, dynamic pricing, price commitment, experience goods

JEL Classification: D42, D82, L15