How do firms react to declining demand? One of the strategies firms could take is to exit the industry. In the current business environment, however, the exit strategy might not be realistic because "[i]n the modern industry, fixed and sunk costs form a relatively large proportion of overall costs which make capacity reduction difficult and costly" (Hausman, 1995).
This dissertation focuses on the strategic use of price when demand is declining. While pricing is a fundamental strategy of firms, it has not been extensively studied in the existing literature on declining industries. However, this strategy could have a large impact because the industry is usually large when it is about to decline. In this situation, incumbent firms could retain or increase profit by controlling price.
From an analytical perspective, the investigation of pricing highlights a new economic interaction: firms and consumers. In the existing literature, declining demand is assumed to be exogenous and unaffected by firm behavior. However, when firms set price as their strategy, they can, at least to some extent, control declining demand. Studying price setting enriches our understanding of firm behavior in declining industry.
This dissertation comprises three papers. The first paper explores some consequences of declining demand in the U.S. market for photographic film due to the introduction of the digital camera. One of the main results is that the demand for film becomes more price-inelastic due to the advent of the digital camera. This causes firms to have two counteracting pricing motives: pricing higher in order to exploit price-inelastic consumers and pricing lower to delay the time at which a consumer switches to a digital camera.
The purpose of the second and third papers is to investigate what theory predicts about price dynamics with declining demand. To this end, the former paper constructs a dynamic model in which a monopoly firm produces an old technology product and its demand declines as a new product appears and spreads among consumers. The paper demonstrates that the price declines over time but its path could be nonmonotonic depending on the distribution of consumers' characteristics. The third paper extends the dynamic model to allow for duopoly firms, and shows the nonmonotonicity of the price path. Through these studies, we identify a systematic property of the price path: the path could be divided into three phases, and the counteracting pricing motives explain each phase.
|Advisor:||Harrington, Joseph E., Jr., Shum, Matthew|
|School:||The Johns Hopkins University|
|School Location:||United States -- Maryland|
|Source:||DAI-A 71/01, Dissertation Abstracts International|
|Keywords:||Declining demand, Dynamic pricing, Industry decline, Myopic consumers, New product, Oligopoly, Price inelastic demand, Pricing|
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