Monopoly pricing in vertical markets with demand uncertainty

Stefanos Leonardos (), Costis Melolidakis () and Constandina Koki ()
Additional contact information
Stefanos Leonardos: Singapore University of Technology and Design
Costis Melolidakis: National and Kapodistrian University of Athens
Constandina Koki: Athens University of Economics and Business

Annals of Operations Research, 2022, vol. 315, issue 2, No 28, 1318 pages

Abstract: Abstract Motivation Pricing decisions are often made when market information is still poor. While modern pricing analytics aid firms to infer the distribution of the stochastic demand that they are facing, data-driven price optimization methods are often impractical or incomplete if not coupled with testable theoretical predictions. In turn, existing theoretical models often reason about the response of optimal prices to changing market characteristics without exploiting all available information about the demand distribution. Academic/practical relevance Our aim is to develop a theory for the optimization and systematic comparison of prices between different instances of the same market under various forms of knowledge about the corresponding demand distributions. Methodology We revisit the classic problem of monopoly pricing under demand uncertainty in a vertical market with an upstream supplier and multiple forms of downstream competition between arbitrary symmetric retailers. In all cases, demand uncertainty falls to the supplier who acts first and sets a uniform price before the retailers observe the realized demand and place their orders. Results Our main methodological contribution is that we express the price elasticity of expected demand in terms of the mean residual demand (MRD) function of the demand distribution. This leads to a closed form characterization of the points of unitary elasticity that maximize the supplier’s profits and the derivation of a mild unimodality condition for the supplier’s objective function that generalizes the widely used increasing generalized failure rate (IGFR) condition. A direct implication is that optimal prices between different markets can be ordered if the markets can be stochastically ordered according to their MRD functions or equivalently, their elasticities. Using the above, we develop a systematic framework to compare optimal prices between different market instances via the rich theory of stochastic orders. This leads to comparative statics that challenge previously established economic insights about the effects of market size, demand transformations and demand variability on monopolistic prices. Managerial implications Our findings complement data-driven decisions regarding price optimization and provide a systematic framework useful for making theoretical predictions in advance of market movements.

Keywords: Monopoly pricing; Revenue maximization; Demand uncertainty; Pricing analytics; Comparative statics; Stochastic orders; Unimodality; 91A10; 91A65; 91B54 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://link.springer.com/10.1007/s10479-021-04067-3 Abstract (text/html)
Access to the full text of the articles in this series is restricted.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:spr:annopr:v:315:y:2022:i:2:d:10.1007_s10479-021-04067-3

Ordering information: This journal article can be ordered from
http://www.springer.com/journal/10479

DOI: 10.1007/s10479-021-04067-3

Access Statistics for this article

Annals of Operations Research is currently edited by Endre Boros

More articles in Annals of Operations Research from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().