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Stochastic Limit Pricing

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  • David M.G. Newbery

Abstract

If a monopolist is selling a commodity to consumers who could, if they chose, produce a close substitute, but only after incurring heavy capital investment (we have oil in mind), then the monopolist's optimal limit pricing strategy may involve randomizing prices even though stable prices would be feasible. This runs counter to intuition, much of which rests on Samuelson's conclusion that where price stability is feasible it is desirable -- a conclusion which is only proved at a competitive equilibrium. The cause of the randomness lies in the nonconvexity of the problem, which appears to be of quite general concern. Indeed, the problem as modeled is formally identical to the choice of optimal commodity taxes which shows that random taxes may be desirable.

Suggested Citation

  • David M.G. Newbery, 1978. "Stochastic Limit Pricing," Bell Journal of Economics, The RAND Corporation, vol. 9(1), pages 260-269, Spring.
  • Handle: RePEc:rje:bellje:v:9:y:1978:i:spring:p:260-269
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    References listed on IDEAS

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    1. Edwin Mansfield & John Rapoport & Anthony Romeo & Samuel Wagner & George Beardsley, 1977. "Social and Private Rates of Return from Industrial Innovations," The Quarterly Journal of Economics, Oxford University Press, vol. 91(2), pages 221-240.
    2. Mansfield, Edwin, 1980. "Basic Research and Productivity Increase in Manufacturing," American Economic Review, American Economic Association, vol. 70(5), pages 863-873, December.
    3. Berndt, Ernst R & Christensen, Laurits R, 1974. "Testing for the Existence of a Consistent Aggregate Index of Labor Inputs," American Economic Review, American Economic Association, vol. 64(3), pages 391-404, June.
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