Dynamic Pricing and Price Commitment of New Experience Goods

This article develops a dynamic model to examine how a firm selling 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 the quality of the product, the firm’s early-period price will endogenously determine the fraction of informed consumers in the later period. Without credible price commitment, the high-quality firm will prefer the pooling outcome in the first period, and in the second period, both types of firms will separate and target only the first-period buyers. By contrast, with credible price commitment, the high-quality firm will be able to profitably signal its quality by lowering its first-period price or increasing its second-period price from its first-best price. Credible price commitment will benefit the high-quality firm by lowering its signaling cost, but can either increase or decrease consumer surplus and social welfare. Furthermore, we show that a longer time horizon can allow the high-quality firm to signal its quality costlessly, by maintaining its high first-best price for all periods.