Working Paper: NBER ID: w21679
Authors: Maxime C. Cohen; Georgia Perakis; Robert S. Pindyck
Abstract: How should a firm price a new product for which little is known about demand? We propose a simple pricing rule: the firm only estimates the maximum price it can charge and still expect to sell at least some units, and then sets price as though the actual demand curve were linear. We show that if the true demand curve is one of many commonly used demand functions, or even if it is a more complex function, and if marginal cost is known and constant, the firm can expect its profit to be close to what it would earn if it knew the true demand curve. We derive analytical performance bounds for a variety of demand functions, and calculate expected profit performance for randomly generated demand curves.
Keywords: No keywords provided
JEL Codes: D40; D80; D81
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| firm estimates maximum price (pm) (D41) | firm achieves profits close to optimal profit (L21) |
| firm sets price as if actual demand curve were linear (D41) | firm achieves profits close to optimal profit (L21) |
| pricing rule performs well under many circumstances (D41) | firm achieves profits close to optimal profit (L21) |
| pricing rule fails under specific demand curves (e.g., rectangular demand) (D43) | firm achieves profits not close to optimal profit (L21) |
| uncertain maximum prices (D44) | pricing rule remains robust (D40) |