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A Model of Recommended Retail Prices

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  • Dmitry Lubensky

    (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)

Abstract

Manufacturers frequently use list prices, suggested retail prices, or other similar forms of non-binding public price recommendations. Despite the prevalence of this practice, why manufacturers make these recommendations and what effect they have on actual prices is still not well understood. I present a model in which price recommendations convey information to consumers about aggregate market conditions. The manufacturer uses recommendations to directly affect consumers' search decisions and thus to indirectly affect the prices set by retailers. The manufacturer faces a tradeoff when influencing search: inducing lower reservation prices reduces retailer markups but also inhibits the manufacturer's ability to extract surplus from consumers with a high willingness to pay. I show that the manufacturer can credibly provide information through cheap talk. Furthermore, I find that a ban on recommendations can be welfare reducing, harming both consumers and the manufacturer. Lastly, I argue that price recommendations are not simply a substitute for price restraints and allow the manufacturer to achieve outcomes that are not attainable with resale price maintenance alone.

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File URL: http://www.bus.indiana.edu/riharbau/RePEc/iuk/wpaper/bepp2011-06-lubensky.pdf
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Bibliographic Info

Paper provided by Indiana University, Kelley School of Business, Department of Business Economics and Public Policy in its series Working Papers with number 2011-06.

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Date of creation: Aug 2011
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Handle: RePEc:iuk:wpaper:2011-06

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  1. Stefan Bühler & Dennis L. Gärtner, 2009. "Making Sense of Non-Binding Retail-Price Recommendations," University of St. Gallen Department of Economics working paper series 2009 2009-02, Department of Economics, University of St. Gallen.
  2. C. Puppe & S. Rosenkranz, 2006. "Why suggest non-binding retail prices ?," Working Papers 06-10, Utrecht School of Economics.
  3. Huanxing Yang & Lixin Ye, 2008. "Search with learning: understanding asymmetric price adjustments," RAND Journal of Economics, RAND Corporation, vol. 39(2), pages 547-564.
  4. John Thanassoulis & David Gill, 2010. "The Optimal Marketing Mix of Posted Prices, Discounts and Bargaining," Economics Series Working Papers 479, University of Oxford, Department of Economics.
  5. G.F. Mathewson & R.A. Winter, 1984. "An Economic Theory of Vertical Restraints," RAND Journal of Economics, The RAND Corporation, vol. 15(1), pages 27-38, Spring.
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Cited by:
  1. Babur De los Santos & In Kyung Kim & Dmitry Lubensky, 2013. "Do MSRPs Decrease Prices?," Working Papers 2013-13, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.

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