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Dynamic pricing in social networks: The Word of Mouth effect

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In this talk, we study the problem of optimal dynamic pricing for a monopolist selling a product to consumers in a social network. The only means of spread of information about the product is via Word of Mouth communication; consumers’ knowledge of the product is only through friends who have already made a purchase. By analyzing the structure of the underlying endogenous process, we show that the optimal dynamic pricing policy for durable products drops the price to zero infinitely often, giving away the immediate profit in full to expand the informed network in order to exploit it in future. We provide evidence for this behavior from smartphone applications, where price histories indicate frequent free-offerings for many apps. Moreover, we show that despite infinitely often drops of the price to zero, the optimal price trajectory does not get trapped near zero. When externalities are present, we show that a strong enough network externality can push the price drops to a nonzero level, but similar price fluctuations to this new price floor still remain. When the product is nondurable, we show that the fluctuations disappear after a finite time.

This talk is part of the CUED Control Group Seminars series.

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