Sloan School of Management
Cambridge, MA 02142
Institutional Affiliation: M.I.T.
NBER Working Papers and Publications
|October 2015||Pricing with Limited Knowledge of Demand|
with Maxime C. Cohen, Robert S. Pindyck: w21679
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.