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Optimal Pricing and Endogenous Herding

Author

Listed:
  • Subir Bose
  • Gerhard O. Orosel
  • Lise Vesterlund

Abstract

We consider a monopolist who sells identical objects of common but unknown value in a herding-prone environment. Buyers make their purchasing decisions sequentially, and rely on a private signal as well as We consider a monopolist who sells identical objects of common but previous buyers’ actions to infer the common value of the object. The model applies to a variety of cases, such as the introduction of a new product or the sale of licenses to use a patent. We characterize the monopolist’s optimal pricing strategy and its implications for the temporal pattern of prices and for herding. The analysis is performed under alternative assumptions about observability of prices. We find that when previous prices are observable, herding may but need not arise. In contrast, herding arises immediately when previous prices are unobservable and the seller’s equilibrium strategy is a pure Markov strategy. While the possibility of social learning is present in the first case, it is absent in the second. Finally, we examine the seller’s incentive to manipulate the buyers’ evaluation of the object when buyers are naive. Using secret discounts the seller successfully interferes with social learning, and herding occurs in finite time.

Suggested Citation

  • Subir Bose & Gerhard O. Orosel & Lise Vesterlund, 2002. "Optimal Pricing and Endogenous Herding," CESifo Working Paper Series 727, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_727
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    File URL: http://www.cesifo-group.de/DocDL/727.pdf
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    References listed on IDEAS

    as
    1. Dirk Bergemann & Juuso Välimäki, 2000. "Experimentation in Markets," Review of Economic Studies, Oxford University Press, vol. 67(2), pages 213-234.
    2. Sushil Bikhchandani & David Hirshleifer & Ivo Welch, 1998. "Learning from the Behavior of Others: Conformity, Fads, and Informational Cascades," Journal of Economic Perspectives, American Economic Association, vol. 12(3), pages 151-170, Summer.
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    Keywords

    herding; informational cascades; optimal pricing;

    JEL classification:

    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General

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