How to Commit to a Future Price

Posted by D. Daniel Sokol

Keisuke Hattori (Osaka University of Economics) and Amihai Glazer (Department of Economics, University of California-Irvine) explain How to Commit to a Future Price

ABSTRACT: Consider a monopolist which sells a durable good and also consumables that require use of the durable good. After the firm sells the durable good, it has an incentive to charge a price greater than marginal cost for the consumables. Realizing that they will have to pay a high price for consumables, consumers would be willing to pay only a low price for the durable good, reducing the firm’s profits. This paper considers three mechanisms which would induce the firm to charge a low price for the consumables. First, it can enter into a financial contract paying a lump-sum fee in return for a per-unit subsidy for the selling the consumable. Second, the seller can allow entry into the market for the consumable. Third, the firm may sell the durable good at a low price to consumers who little value the durable and consumable, so that it will have an incentive to later set a low price for the consumable.