Dynamic Learning in Markets: Pricing, Advertising, and Information Acquisition

Abstract

In the face of demand uncertainty, a monopolist can observe sales as a controlled reaction to its price and advertising so as to improve the choice of this marketing mix in the future. Furthermore, to upgrade its knowledge about demand the firm has the option to invest in external market intelligence and thus to directly acquire relevant information. Using a two-period model we determine the firm's profit-maximizing learning strategy using all three of these levers: price, advertising, and information acquisition. This illustrates the firm's tradeoff of actively managing its consumer base through costly marketing, exploiting expected demand through pricing, and increasing the efficiency of its actions by means of costly outside information. An extension of the model to the case with internal budget constraints on information acquisition is provided, and a numerical example is discussed.