Dynamic Pricing of Network Goods with Boundedly Rational Consumers. Working Paper CeDER-06-03

An important simplifying assumption made when analyzing goods that display positive net-work effects is that potential consumers can form a rational expectation of the equilibrium demand for the good, and that they all form the same expectation, which is then fulfilled based on their consumption choices- sometimes called a rational expectations equilibrium (REE). We examine whether the results of these models are robust to the relaxation of this assumption. In our model, consumers differ in their marginal utility of total demand (intensity of the network effect), which varies according to a given distribution (the distribution of consumer "types"), and are boundedly rational in two ways. First, only a fraction of consumers "pay attention" to price announcements in any interval of time. Second, those consumers who pay attention make their consumption choices based on a boundedly rational expectation of future demand. Our benchmark model is of myopic expectations, although we show how our results generalize (1) to a case in which the population of consumers contains both those who are myopic and those who are "fully rational, " and (2) to a case in which consumers have expectations that are partly "stubborn". We base our analysis on a continuous-time approximation of an underlying ∗We thank Philipp Afeche, Joseph Harrington and workshop participants at Boston University, New York Univer-sity and the Sixteenth Workshop on Information Systems and Economics for their feedback