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A Model of Recommended Retail Prices

  • Dmitry Lubensky

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

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://kelley.iu.edu/riharbau/RePEc/iuk/wpaper/bepp2011-06-lubensky.pdf
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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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