Optimal Pricing of Experience Goods

Abstract

A monopolist's optimal price path over time is examined for situations in which consumers initially misestimate product quality and learn about it by using the good. Information about the product is bundled with the product itself. Two very different cases are studied. In the optimistic case, consumers initially overestimate quality, and the optimal way to milk a reputation is via a declining price path followed by a jump up to a terminal price. There are no long-run effects due to initial misperceptions. In the pessimistic case, consumers underestimate quality, and the optimal way to build a reputation is to use a low introductory price followed by a higher regular price. In this case, initial misperceptions adversely affect welfare in both the short and long run.