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Misspecified profit functions and full-cost pricing

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  • Choné, Philippe
  • Linnemer, Laurent

Abstract

We study the behavior of a firm that consistently maximizes a misspecified profit function as the misspecification error remains undetected in equilibrium. Our framework encompasses a price-taking firm and a cost-taking firm, which respectively take the unit price and the unit cost as given. At the stable equilibrium for the cost-taking firm, the price increases with the level of fixed costs, a phenomenon known as full-cost pricing. We show that the equilibrium price may be lower than the rational price and can be reached by a tatonnement process. We also describe a stochastic version of that process in a dynamic setting with random costs and Bayesian learning. Finally, we endogenize the cost curve. When technology duplication is possible, the cost-taking firm and the rational firm end up producing the same level of output.

Suggested Citation

  • Choné, Philippe & Linnemer, Laurent, 2023. "Misspecified profit functions and full-cost pricing," CEPR Discussion Papers 18240, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:18240
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    More about this item

    JEL classification:

    • L12 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Monopoly; Monopolization Strategies
    • L21 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Business Objectives of the Firm
    • L23 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Organization of Production
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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