Mark-Up Pricing Under Demand Uncertainty
28 Pages Posted: 17 Apr 2009 Last revised: 25 Mar 2015
Date Written: June 1, 2009
Abstract
This paper extends the mark-up rule relating a firm’s profit-maximizing price to its marginal cost and its elasticity of residual demand to the news vendor problem with endogenous pricing. Two adjustments are necessary. First, the relevant elasticity of demand is the elasticity of the average quantity sold with respect to price. Second, marginal cost is the marginal cost per unit of an expected unit sold, computed as the marginal cost of an additional unit produced divided by the expected fraction of the marginal unit produced that the firm sells. Applying this rule clarifies why increased uncertainty about demand can cause an increase in output with additive uncertainty and a reduction in output with multiplicative uncertainty.
Keywords: problem, demand uncertainty, mark-ups, Lerner Index
JEL Classification: D40, D42, D80
Suggested Citation: Suggested Citation