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Pricing as a risky choice: Uncertainty and survival in a monopoly market

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  • Andersen, Per
  • Vetter, Henrik

Abstract

Roy (Safety First and the Holding of Assets, 1952) argues that decisions under uncertainty motivate firms to avoid bankruptcy. In this paper, the authors ask about the behaviour of a monopolist who pre-commits to price when she has only probabilistic knowledge about demand. They argue that pricing in order to maximise the likelihood of survival explains anomalies such as inelastic pricing, why the firm takes on more risk as gains become less likely, and asymmetric responses to demand and cost changes. When demand is a linear demand, the monopolist's response to an increase in the marginal cost is similar to the response when mark-up pricing is used. That is, there is a one-to-one relationship between an increase of the marginal cost and an increase in price.

Suggested Citation

  • Andersen, Per & Vetter, Henrik, 2015. "Pricing as a risky choice: Uncertainty and survival in a monopoly market," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 9, pages 1-22.
  • Handle: RePEc:zbw:ifweej:201529
    DOI: 10.5018/economics-ejournal.ja.2015-29
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    References listed on IDEAS

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    1. Allen, Beth & Hellwig, Martin, 1986. "Price-Setting Firms and the Oligopolistic Foundations of Perfect Competition," American Economic Review, American Economic Association, vol. 76(2), pages 387-392, May.
    2. van Dalen, Jan & Thurik, Roy, 1998. "A model of pricing behavior: An econometric case study," Journal of Economic Behavior & Organization, Elsevier, vol. 36(2), pages 177-195, August.
    3. Day, Richard H & Aigner, Dennis J & Smith, Kenneth R, 1971. "Safety Margins and Profit Maximization in the Theory of the Firm," Journal of Political Economy, University of Chicago Press, vol. 79(6), pages 1293-1301, Nov.-Dec..
    4. Klaus M. Schmidt, 1997. "Managerial Incentives and Product Market Competition," Review of Economic Studies, Oxford University Press, vol. 64(2), pages 191-213.
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    More about this item

    Keywords

    monopoly; uncertainty; safety-first principle;
    All these keywords.

    JEL classification:

    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • 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

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