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 how many consumers are informed in the later period. Without price commitment, the high-quality firm prefers the pooling outcome in the first period, generating enough informed consumers such that the second period will be separating with both types of firms serving only their respective first-period buyers. By contrast, with price commitment, the high-quality firm can signal its quality by committing an increasing price-path and may find it optimal to commit a future price that is higher than its first-best price. Price commitment will benefit the high-quality firm by lowering its signaling cost, but can either increase or decrease consumer surplus and social welfare. Furthermore, we demonstrate that the high-quality firm can provide price protection to endogenously establish the credibility of its price commitment. Lastly, 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.

Keywords: dynamic signaling, price commitment, price protection, experience goods, pricing, learning, price-match guarantee

JEL Classification: D42, D82, L15