Dynamic versus Static Pricing in the Presence of Strategic Consumers

Should a firm's price respond dynamically to shifts in demand? With dynamic pricing the firm can exploit high demand by charging a high price, and can cope with low demand by charging a low price to more fully utilize its capacity. However, many firms announce their price in advance and do not make adjustments in response to market conditions, i.e., they use static pricing. Therefore, with static pricing the firm may find that its price is either lower or higher than optimal given the observed market condition. Nevertheless, we find that when consumers are strategic and can anticipate such pricing behavior, a firm may actually be better off with static pricing. Dynamic pricing can be ineffective because it imposes pricing risk on consumers - given that it is costly to visit the firm, an uncertain price may cause consumers to avoid visiting the firm altogether. We show that the advantage of dynamic pricing over static pricing. However, the superiority of dynamic pricing can be restored if the firm sets a modest base price and then commits only to reduce its price, i.e., it never raises its price in response to strong demand. Hence, a successful implementation of dynamic pricing tempers the magnitude of price adjustments.