Behavior-based pricing and signaling of product quality

Abstract

In a two-period model with repeat purchase, we compare the profit and social welfare effects of behavior-based pricing (BBP) and uniform pricing in a monopoly under quality uncertainty. We offer the novel insight that BBP increases the price elasticity of imitation demand and lowers the signaling cost relative to uniform pricing, and becomes a potentially profitable strategy even when the monopolist cannot commit to future prices. Moreover, the profitability of BBP does not arise at the expense of consumer surplus. Either upward or downward price distortion with the use of BBP signals high quality, depending on the seller's commitment power. With more accurate tracking technology, the monopolist may forsake signaling for better consumer information.