Dynamic Pricing and Price Commitment of New Experience Goods

Abstract

This study develops a dynamic model to examine how a firm selling new non‐durable experience goods can signal its high quality with dynamic spot‐pricing or price commitment. Since consumers who buy and use the product will learn its quality, the firm's early period price will endogenously determine the number of informed consumers in the later period. Without price commitment, the high‐quality firm prefers the pooling outcome in the first period, generating enough informed consumers to induce a separating equilibrium outcome in the second period where both types of firms serve only their respective first‐period buyers. By contrast, if firms can commit to future prices, the high‐quality firm can signal its quality by committing to an increasing price‐path, either a lower‐than‐first‐best price for the early period with a first‐best price for the later period or the first‐best early period price with a higher‐than‐first‐best future price. Price commitment will benefit the high‐quality firm by lowering its signaling cost and hurt the low‐quality firm by increasing its cost of mimicking the high‐quality firm. Interestingly, the firm's price commitment can either increase or decrease consumer surplus and social welfare. We show that a longer time horizon can allow the high‐quality firm to costlessly signal its quality by maintaining its high first‐best price for all periods. Our results are robust even when social learning (e.g., through consumer reviews) is considered.