Dynamic Pricing of Network Goods with Bounded Rationality

Start: 04/15/2010 - 4:15pm
End  : 04/15/2010 - 5:15pm

Statistics/OR/Math Finance Seminar

Ami Radunskaya (Pomona)


Some goods are more valuable when more people own them: a classic example is a telephone network. In this talk we try to answer the question: What is the optimal pricing strategy for such goods? In contrast with the standard notion of a ``rational-expectations equilibrium", where consumers are assumed to react instantly to changes in price, always doing what is best for them, we model consumers as ``boundedly rational", and unable either to pay immediate attention to each price change, or to make accurate forecasts of the adoption of the network good.

Our analysis exploits a nice interplay between the qualitative features of differential equations and optimization theory. We derive an optimal pricing policy, and show that this pricing policy is robust to a number of extensions, which include the product's user base evolving over time, and consumers basing their choices on a mixture of a myopic and a "stubborn" expectation of adoption. Our results differ significantly from those that would be predicted by a model based on rational-expectations equilibrium, and are more consistent with the pricing of network goods observed in practice.

Co-authors: Roy Radner and Arun Sundararajan, Stern School, New York University.

Harvey Mudd College Sprague Building 3rd Floor seminar space Refreshments at 4pm