Shopping for Information: Consumer Learning with Optimal Pricing and Product Design

Abstract

I study a monopolistic pricing problem in which the consumer performs product research to determine whether or not to purchase a good. The consumer receives a signal of quality via a Brownian motion process with a type-dependent drift. I fully characterize the consumer’s optimal strategy; she buys the product when she is sufficiently optimistic about the quality and ceases to pay for the signal when she is sufficiently pessimistic. I examine the implications of this behavior for the seller’s optimal pricing decision. I find that the seller prefers to encourage product research when quality is likely to be high and prefers to discourage research when quality is likely to be low. I show that a decrease in search costs or an increase in the quality of information can either raise or lower equilibrium price. I also extend the model so that the seller chooses both price and the level of quality dispersion and demonstrate that the optimal level of dispersion need not be extremal.

Keywords: Pricing, Real Options, Learning, Brownian Motion, Product Research, Product Design

JEL Classification: D11, D21, D42, D83, L12