Thursday, March 27, 2014
Dmitry Lubensky (Department of Business Economics and Public Policy, Indiana University Kelley School of Business) offers A Model of Recommended Retail Prices.
ABSTRACT: Consumers rely on a manufacturer's recommended price to help determine whether to accept a retailer's price or continue to search. This paper demonstrates that doing so can be rational even if the manufacturer's price recommendation is cheap talk. By incentivizing search, a manufacturer trades off reducing double marginalization and losing consumers to competitors. When the manufacturer's cost is low he induces low retail prices and benefits when consumers search more. When the manufacturer's cost is high he induces high retail prices and benefits when consumers search less. Since consumers prefer to search more when lower prices are available, their incentives are aligned with the manufacturer's and this allows informative cheap talk communication. Aside from costs, the manufacturer can inform consumers of other market parameters such as product quality.