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Estimating the buyer's willingness to pay using Bayesian belief distribution with IFR

Listed author(s):
  • Brusset, Xavier
  • Cattan-Jallet, Roxane

In supply chain management, information about the downstream party's willingness to pay (wtp) for a service or a good sold by an upstream party may not be known to the latter. The seller has to make an educated guess for the price at which to offer a good or service. If the buyer refuses to buy, the seller can still turn to a third party and sell at a lower price or hold onto the good. We show that the seller has one interior profit maximizing price if his Bayesian belief about the buyer's wtp follows a distribution which has an increasing failure rate (IFR) in the sense of \cite{bar3}. We prove that the precision of information available to the supplier influences the rent distribution and how the downstream party might opportunistically mis-inform the upstream partner. We propose another reading of the single-price newsvendor problem in Lariviere and Porteus (2001), Ziya et al. (2004a,b), Paul (2006) or Lariviere (2006). Our approach applies to all types of mechanism design problems where a profit-maximizing party has to rely on Bayesian belief to palliate information asymmetry and has alternative sources of income or cost.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 22638.

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Date of creation: 09 Oct 2009
Date of revision: 10 May 2010
Handle: RePEc:pra:mprapa:22638
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  1. Anand Paul, 2005. "A Note on Closure Properties of Failure Rate Distributions," Operations Research, INFORMS, vol. 53(4), pages 733-734, August.
  2. Martin A. Lariviere & Evan L. Porteus, 2001. "Selling to the Newsvendor: An Analysis of Price-Only Contracts," Manufacturing & Service Operations Management, INFORMS, vol. 3(4), pages 293-305, May.
  3. Oliver D. Hart & Jean Tirole, 1988. "Contract Renegotiation and Coasian Dynamics," Review of Economic Studies, Oxford University Press, vol. 55(4), pages 509-540.
  4. Martin A. Lariviere, 2006. "A Note on Probability Distributions with Increasing Generalized Failure Rates," Operations Research, INFORMS, vol. 54(3), pages 602-604, June.
  5. Serhan Ziya & Hayriye Ayhan & Robert D. Foley, 2004. "Relationships Among Three Assumptions in Revenue Management," Operations Research, INFORMS, vol. 52(5), pages 804-809, October.
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