Out 2

T im in g o f S ales w ith H e te r o g e n e o u s C o n su m er
P a tie n c e
C han gxiu Li
Submitted in partial fulfillment of the

Requirements for the degree of
Doctor of Philosophy
in the Graduate School of Arts and Sciences
C O L U M B IA U N IV E R S IT Y
2007
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Changxiu Li
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ABSTRACT
T im in g o f S ales w ith H e te r o g e n e o u s C o n su m er
P a tie n c e
Changxiu Li
This dissertation models retailers pricing strategies in holding sales for

everyday and seasonal goods. Sales are integral to an inter-temporal non-linear
pricing schedule adopted to price discriminate between distinct types of con
sumers, each characterized by a two dimensional vector representing valua
tion/patience and preferred consumption time. Two types of product: everyday
goods and holiday goods are investigated, to capture two different motivations
for sales.
Chapter 2 concerns a monopoly sellers pricing with a single product.
For everyday goods, he sells to higher valuation customers on a regular basis,
and periodically reduces the price to clear the market for the low valuation
customers. For a seasonal/holiday good, a firm sells to the high type at the
holiday, while low type consumers make their purchases at a pre- or a post
season sale.
Chapter 3 deals with the multi-firm oligopoly competition in sales strate
gies. A closed-form symmetric competitive equilibrium and the most profitable
collusive equilibrium are derived, with the patterns of sales being qualitatively
similar to the monopoly outcome, and firms alternate in holding them. The
model provides a plausible explanation of the empirical pattern of sales, and a

simple data application verifies many of these predictions.
Complementary products pricing is explored in chapter 4. For everyday
goods, separating sales for the two products earn the monopoly firm higher
profit than pooling sales. Yet separating the complements does not contribute
more for holiday goods.
The last chapter concludes.
C ontents
L ist o f T ab les
iv
L ist o f F ig u res
A ck n o w led g m en ts
C h a p ter 1
vi
O v erv iew
1.1
In tro d u ctio n .........................................................................................
1.2
Literature R eview ................................................................................
1.2.1
Static Sales L ite r a tu r e .........................................................
10
1.2.2
Dynamic Sales Literature
...................................................
11
1.2.3
Price Discrimination with Multi-dimensions or Competi
tion Literature
......................................................................
16
C h a p ter 2
M o n o p o ly M ech a n ism D e sig n
20
2.1 The M odel.............................................................................................
21
2.2 Analysis of Everyday G o o d s .............................................................
24
2.3 Analysis of Holiday G o o d s .................................................................
33
C h a p ter 3
O lig o p o ly S y m m etric E q u ilib riu m
39
41
.................
52
3.2.1
Data D e sc rip tio n ...................................................................
52
3.2.2
R esu lts......................................................................................
55
3.3 Analysis of Holiday G o o d s .................................................................
59
3.2 Empirical Evidence from Supermarket Scanner D ata
C h a p ter 4
M o n o p o ly C o m p lem en ta ry P r o d u c ts P ricin g
63
4.1 The M odel................................................................................
64
66
4.3 Analysis of Holiday G o o d s ................................................................
79
C h a p ter 5
C o n clu sio n
83
ii
A p p e n d ix A A p p e n d ix
93
A .l Proofs of the Lemmas and P ropositions..........................................
93
A.2 Comparison with CGS (1984) and Sobel (1991) for Everyday
Goods M o n o p o ly ................................................................................
A.3 Adopting a Spokes Model for Everyday Goods Oligopoly . . . .
iii
113
117
List o f Tables
3.1
D ata D e sc rip tio n ................................................................................
54
3.2
R e g re ssio n s .........................................................................................
58
iv
List o f Figures
2.1
Purchase Time D is to r tio n ................................................................
28
2.2
Monopoly Everyday Good P r i c e ......................................................
30
2.3
Monopoly Holiday Good P r ic e .........................................................
36
3.1
Oligopoly Everyday Good P r i c e ......................................................
46
3.2
Charmins versus N o rth e rn ...............................................................
56
3.3
Scott P r i c e s .........................................................................................
56
3.4
Oligopoly Holiday Good P r i c e .........................................................
60
4.1
Monopoly Complementary Goods P r i c e s ......................................
76
A cknow ledgm ents

I would like to give the most sincere appreciation to the members of my
defense committee: Kyle Bagwell, Yeon-Koo Che, Michael Riordan, Bogachan
Celen and Catherine Thomas.
I would not survive my Ph.D. successfully without the continuous encour
agement and guidance of my sponsor, Michael Riordan, who is always generous
with his time and ideas. This dissertation originated when I was under Michaels
supervision, and I owe him an intellectual debt. I am grateful to Yeon-Koo Che
for his vast knowledge of 10 theory and excellent advice, which saved me enor
mous time and effort otherwise. Always a great consultant to me, Kyle Bagwell
severely benefits me with his expertise and patience.
I am also grateful to Mitali Das, who is both a great mentor and a friend.
Her "you can do it" serves as a motivation and a source of confidence for me to
conquer the challenges on the road. I want to thank my friends, Feng-chun Yu,
for a warm friendship for five years, Ting Wu, for discussions about my research
and Rajeev Cherukupalli, for the valuable help to polish my dissertation writing.
I must thank my parents for their selfless love and support, who made
this possible, bearing a baby and a dissertation at the same time.
And to
my husband, bearing with me at my ups and cheering me at my downs, he is

always there with great tolerance and deep love. We share so much in common,
interests, experiences, and a five years happy marriage so far. A lovely beautiful
vi
daughter Melody is added to the list recently. She completes me as a mother

with great joy.
vii
To my parents, my husband and my daughter Melody.
viii
C hapter 1
O verview
1.1
In tr o d u ctio n
Price dispersion among retailers is a commonly observed phenomenon,

both across location and time. A particular retail store changes its product
price periodically, and sometimes frequently over time. This price fluctuation,
is usually termed a sale (or price break, markdown or discount) at its lowest
point, and is considered a strategy for firms to extract greater profits by intertemporally discriminating between different kinds of consumers.
Static price dispersion, which accounts for the price difference across loca
tions, has been widely studied since the early 1980s. Dynamic price dispersion,
or price variation across time, has been less thoroughly investigated. This dis
sertation presents a model th at explains firms behavior in announcing periodic
and/or seasonal sales. The questions th at this dissertation seeks to answer are
why sales occur, how they are timed, the best sales mechanism design for a
monopoly firm and the symmetric equilibria of sales under an oligopoly market
competition.
The theoretical literature on sales originated in the late 70s with its
starting point as the often observed failure of the Law of One Price. Represen
tatives of the literature on static sales are Varian (1980) and Salop and Stiglitz
(1982). Varian presents a model in which sellers pursue mixed strategies. Price
dispersion is the result of a stores price discrimination between informed and
uninformed consumers. Salop and Stiglitz show th at stores might use sales to
induce consumers to purchase for future consumption, so that sales are used to
stimulate demand and profit.
This dissertation is most closely related to the literature on dynamic
sales. Conlisk, Gerstner and Sobel (1984), henceforth CGS, Sobel (1984) and
(1991) investigate the dynamic decision of announcing a sale for a durable good
in monopoly and oligopoly markets. Sobel (1991) is an update of the Nash equi
librium in CGS with a subgame perfect Nash equilibrium scenario. The key idea
of these three papers is that sales are a means of inter-temporal discrimination
among consumers with different levels of valuation, and that idea is carried over
here.
Both CGS and Sobel (1991) assume a durable good market, a monopolist
seller, a continuous influx of new consumers, and two types of consumers with
different valuations. They show a noncommitment equilibrium where the firm
pursues cyclic pricing. The price is reduced steadily over the course of a cycle,
from the high types reservation price and ending at the reservation price of the
low type, which is the time of a sale. The price jumps up immediately to the
high reservation price after the sale day. Further, a mechanism design analysis
assuming firms commitment power shows th at there does not exist any strategy
that earns more profit for the monopoly firm other than sticking the price to
either high types or the low types valuation. Inter-temporal discrimination is
not a profitable mechanism in a committed seller setting. Sobel (1.984) applies
a very similar model to an oligopoly market environment. As with a monopoly,
the incentive of a sale for the firm is to clear the low type as they accumulate
in the market. A mixed strategy symmetric equilibrium is delivered.
There are models stressing cyclical firm conduct, most of which follow the
approach of cyclical demand elasticity shocks and/or imperfectly competitive
market with collusive behavior among firms. Gale and Holmes (1993) investi
gate the mechanism design problem for peak and non-peak pricing for airline
tickets. Chevalier, Kashyap and Rossi (2003) empirically test the countercycli
cal pricing pattern of seasonal goods, consistent with a "loss-leader" model of
retailer competition. The main focus of this dissertation is on non-seasonal good
sales patterns. In contrast to early work, based on committed seller assumption,
it demonstrates that cyclic pricing can be optimal even with constant demand
and supply over time. It also predicts cyclic seasonal products sales, with a
high price during a holiday period, and a pre-season and/or a post-season sales
before and after, which aligns with a common observation in fashion and airline
industries.1
This dissertation enriches the work on price discrimination and compe
tition by drawing on the growing literature on multi-dimensional preferences.
Price discrimination conventionally signifies a nonlinear pricing schedule with re
spect to either product quality or quantity. Mussa and Rosens (1978) milestone
paper solves a standard monopoly second degree price discrimination problem.
Successive works extend the model to a multi-dimension space of preferences,
multiple units of purchase, a multiple number of products and a multiple num
ber of firms in the market.
Most works extending in this direction find it
hard enough to obtain any closed form solutions, even for a two-dimensional
case, unless very special assumptions apply. Armstrong (1996) points out that
one reason for this difficulty is the violation of the participation constraints.
W ith consumers with multi-dimensional preferences, a firm would have to ex
clude some low demand consumers from the market in its optimization. Rochet
and Stole (2002) introduce a random reservation value along with an unknown
1Therefore, this cyclic pricing is opposite to Chevalier, Kashyap and Rossi (2003) !s finding.
One reason for the different result is that the current model does not incorporate multi-goods
production and the interaction of the demands of multi-products.
valuation of quality. The model developed in this dissertation works in two di

mensional preference space; the two dimensions being valuation and a preferred
consumption timing distribution.
Rochet and Stole (2002), Armstrong and Vickers (2001) and Katz (1984)
concern themselves with price discrimination in an oligopoly market. The first
two papers employ a Hotelling model to capture competition. Both find out
that when the market is covered, or competitive enough, distortion disappears
and a cost-plus-fee pricing is adopted. They argue that, for the firms, the need
to compete dominates the benefits from screening the consumers. Katz (1984)
also obtains a similar result using an uninformed consumer to limit market com
petition. These findings are consistent with the result in the model developed
here.
The literature on multi-product, monopoly is extended in the fourth chap
ter, where the focus is on complementary goods selling strategy. Monopolist
packaging of two or more products in bundles rather than selling them indi
vidually serves as a useful price discrimination device, as suggested by Adams
and Yellen (1976) and McAfee, McMillan and W hinston (1989) through a sta
tic analysis. My model argues th at separate selling dominates bundling, for
complementary goods following a dynamic investigation.2
This dissertation is fundamentally concerned with mechanism design in
2Most, of the papers mentioned above and several more will be discussed, summarized and
compared in more depth in the literature review section.
sales. The Revelation Principle is usually invoked in the theory of implementa

tion and mechanism design under imperfect information. Yet, this principle has
been challenged for the requirement of the credible commitment of the mecha
nism designer.3 Firms full commitment to the mechanism outcome is assumed
throughout in the current context. The argument for full commitment is based
on the following reasons. First, a far-sighted firm would commit itself due to the
reputation consideration. Second, in reality, many stores offer predictable and
reliable sales for certain goods: Victoria Secrets two pre-announced semi-annual
sales and Amazons diaper sales are examples of an established phenomenon.
Last but not least, the optimal strategy under commitment derives different re
sult from previous findings in the literature4: a cyclic pricing for products with
stable demand and supply.
This dissertation contributes to the economics literature on sales in sev
eral ways.
The models here incorporate the approaches of two types of consumers
with different valuation/patience with continuous distribution with respect to
preferred consumption time, and use a continuous time dynamic model to ex
plain the timing decision of sales.5
3For a more detailed discussion, see Bester and Strausz (2001).
4One example is Sobel (1991).
5Similar two types consumers assumption is used in Varian (1980), Conlisk, Gerstner and
Sobel (1984), Sobel (1984) (1991), and Katz (1984) as well.
The main contribution is to thoroughly solve, for the first time, the sales
timing problem, with a closed-form prediction of sales prices and frequencies.
Economists have increasingly directed attention to the topic of timing decision,
and empirical work on timing of sales in various industries, timing of movie
release and timing of tickets sales reveal some interesting patterns of dynamic
sales behavior of firms. There is a lack, however, of a systematic model to
explain this empirically observed sales behavior and equilibrium in the market,
and this dissertation attem pts to address th at gap. A monopoly firms sales
strategy with a single product, an oligopoly equilibrium in sales with multifirms in the market and a more complicated problem of monopolists sales in
complementary goods are all tackled in the dissertation.
The results of the model developed are quite consistent with the empirical
findings from previous work, as is verified with a simple data application in
the oligopoly section using supermarket scanner data.
For everyday goods,
such as bottled water, refrigerator and bathroom tissue whose demand does
not fluctuate appreciably with seasonal or holiday trends, the model predicts
regular periodic discrete sales events. For seasonal goods, covering products as
diverse as swimwear, back-to-school supplies and Christmas trees, the separating
equilibrium of the model predicts a pre-season and/or a post-season sale, with
the product price being at its highest in season. These predictions coincide with
widely observed phenomena in markets.
The second contribution is more fundamental. The model developed

allows two-dimensional private information of the consumers, with a continuous
timing dimension, and a discrete valuation dimension. This two dimensional
preference set is non-convex, thus circumventing the violation of participation
constraint.6 Differences in valuation/patience among consumers determine the
profitability of firms screening behavior, while the preferred consumption time
distribution reinforces the timing strategy.
The main content of the dissertation is developed in the next three chap
ters. After a brief literature survey, Chapter 2 presents the benchmark model
of a monopoly firms sales mechanism in selling a single product. An every
day product and a holiday product sales strategies are explored respectively.
Chapter 3 solves the oligopoly N firms symmetric equilibrium, and an em
pirical application on the data of bathroom tissue in Dominicks Finer Food
supermarket is performed to verify the models prediction. The fourth chapter
examines the optimal sales pattern of a monopoly firm with two products that
are complementary to each other. Chapter 5 concludes. Long proofs and some
comments are contained in the appendix.
1.2
L itera tu re R e v ie w
6See Armstrong (2000) for more discussion.
The theoretical literature of sales originates with the observation of failure

of Law of One Price. In the late 70s, economists began modeling the phenomena
of the existence of price dispersion at a given time. The research and debate at
the time mainly focused on varied sources of explanation for these static sales. In
early 80s, the timing problem was brought as an issue. Economists investigated
the dynamic fluctuation of price overtime. Pricing distinction was thus extended
to a two-dimension problem: at the same time across different stores or at a
certain store across time. The structure of this review of the literature will
follow this evolution in theory, from static to dynamic. The market structure
under which static sales are studied is oligopoly, as this best describes the nature
of price dispersion over stores. In the dynamic sales literature, both monopoly
and oligopoly market environments are investigated.
In this dissertation, the dynamic sale is treated as a form of inter-temporal
price discrimination behavior for firms. Therefore, a brief introduction and re
view of previous works in price discrimination and non-lineax pricing literature
is a necessity. Two sub-groups of this literature are especially relevant. The
first is price discrimination with a multi-dimensional preference space, since the
model here assumes a two dimensional consumer preference. The second strand
of literature is on oligopoly competition with price discrimination, as this is the
focus of Chapter 3. In most works, the non-linear relation is between the price
and the product quality or quantity. The model developed below presents a
10
nonlinear pricing with respect to time.
1.2.1
S ta tic Sales L iterature
The most influential analysis of static sales are Varian (1980) and Salop
and Stiglitz (1982). These authors propose different explanations to the exis
tence of varied prices across stores in the market. The two incentives th a t these
seminal works advance for firms to hold sales are still the foundations of more
complicated and sophisticated sales theory th at followed.7 The first incentive is
to price discriminate towards different types of consumers, and the second one
is to encourage consumers inventory purchase.
Observing a large degree of price dispersion, the model in Varian (1980)
explains it through a heterogeneous consumers approach. He considers a mar
ket composed of two types of consumers, informed and uninformed ones. Un
informed consumers choose a store randomly and will make a purchase if its
price is below their valuation. Informed consumers, on the other hand, know
the entire distribution of prices and always go to the lowest priced store. In the
equilibrium, stores pursue a mixed strategy and randomize prices to discrimi
nate between informed and uninformed consumers.
Salop and Stiglitz (1982) assume identical two-period life consumers, in
' For example, the discrimination incentive affects the work of Sobel and Gale and Holmes.
And the second thought on storage encouragement is carried over to Hendal and Nevo. Katzs
model incorporates both incentives.
11
contrast to Varians approach. Firms charge different prices in the dispersion

equilibrium, "younger" customers who happen to go to the high price store
purchase only for current need, while those who go to the low-price store double
purchase for both current need and future storage. In the equilibrium, equal
profits are required. Therefore, the high earning per sale for the high-price store
precisely compensates the low volume sold. This pure strategy equilibrium is
from the implicit assumption of common knowledge about prices among the
identical sellers.
1.2.2
D yn am ic Sales L iterature
Sobefs works on dynamic sales are the most recognized and prominent
in the dynamic sales literature. His three papers
011
this topic are most closely
related to the model in this dissertation.

The first work on the topic of dynamic sales is by Conlisk, Gerstner and
Sobel (1984).8 They model the noncommitment equilibrium with a monopolist
seller in a durable good market. Applying Varians heterogeneous consumers
approach, they assume two types of consumers, high and low, according to
their valuation. Both types of consumers arrive at the market at a constant
rate, and leave the market forever after one unit purchase. The firm charges a
high price in most periods, with sales only to newly entered consumers having
8Henceforth abbreviated as CGS.
12
a high reservation price. Periodically, the monopoly drops the price low enough
to clear the accumulated group of low-valuation consumers, and the price rises
immediately after a sale day. A durable good market, a monopolist seller, a
continuous influx of new consumers, and two types of consumers with different
valuations are assumed in this paper. In the equilibrium, the price falls from
the high type reservation price steadily during a cycle, ending at the reservation
price of the low type, which is a sale. The continuous influx of new consumers
results in the cycles of this equilibrium price path.
Sobel (1991) is an update paper of CGS (1984) in a subgame perfect equi
librium scenario instead of a noncommitment equilibrium concept. He proves
the folk theorem result th at if both types of consumers are sufficiently patient,
any positive average profit less than the maximum feasible level can be attained
in an equilibrium that is supported by punishment strategies. In contrast to
the Coase property and early works,9 the equilibrium involves cyclic variation
in price, even when the period length goes to zero. When commitment is feasi
ble, the seller obtains the highest profit by charging the static monopoly price
in each period. Sobel sets up a direct mechanism and shows th at the optimal
mechanism is to permanently charge either the high types valuation or the low
typess valuation dependent on the market composition of the two types.
Sobel (1984) examines the equilibrium of inter-temporal price discrimi
9Such as Ausubel and Deneckere (1989) and Bond and Samuelson (1984) and (1987).
13
nation in an oligopoly market. Most of the assumptions on the product and

consumers are the same as CGS (1984), such as a durable good and continu
ous inflow of two types of consumers with different valuation. An assumption
that is especially relevant is that the high type consumer is loyal. Therefore,
stores can maintain a high price because of their monopoly power over their
loyal customers. There is also an incentive for a sale in order to clear the low
types as they accumulate in the market. Sobel finds a simple mixed strategy
symmetric equilibrium, in which there exists a critical time length such that
sellers charge only high prices within this duration after a sale. Afterwards,
they use mixed strategies between a high price and the sale price. The equilib
rium requires equal expected profit for all firms and this profit level is the same
as the monopoly profit from loyal customers only without holding sales.
In this dissertation, some ideas from Sobel and CGS are carried over to
my model, such as the two types of consumers with different valuations, the
unit purchase property product, and the loyal high type customer assumption.
There are major differences and extensions in my modelling and results,
from at least the following six perspectives. First, the key different assumption
here is the heterogeneous patience level. H types are less patience in waiting and
postponing consumption than the L types. Second, I obtain a cyclic pricing pat
tern as the optimal mechanism with a committed seller, which makes more sense
in explaining the sales observed in real life, while Sobel (1991) predicts a flat
14
price in a commitment mechanism design. Third, I find a closed-form pure strat

egy symmetric equilibrium in the oligopoly competition assuming commitment,
while Sobel derives a noncommitment mixed strategy equilibrium. Fourth, the
direct incentive to hold a sale in my model is to discriminate consumers with
different patience level. In Sobel"s work, the incentive is to clear the L types
as they account too high a portion of the demand. Fifth, time in my model is
continuous, while Sobel and CGS use discrete timing. And lastly, consumers
preference here is in a two dimensional space, valuation/patience and preferred
consumption time. In Sobels models, the only dimension is consumers valua
tion once they arrive in the market.
Lazear (1986) focuses on a dynamic analysis of retail pricing and clear
ance sales, especially for a monopoly firm marketing a new product th at is not
unique. He explains sales through the approach of incomplete information for
firms about consumers reserve price distribution. The key underlying idea is
that the fact th at a good cannot be sold in the first period probably means that
the firm is charging higher than consumers valuation. Thus, the outcome of the
previous stage provides additional information and the seller adjusts his prior on
consumers reserve price distribution and objective function accordingly. The
major result of this profit maximization problem is that prices start high and
fall as a function of time on the shelf. The speed of this fall and the initial
price positively correlate with the number of customers per unit time, the ratio
15
of buyer versus window shoppers and the prior uncertainty about the value of
the goods. Imperfect information of the reserve prices results in the decreasing
path of pricing over time for a new release product.
In Gale and Holmes (1993), a mechanism design problem is solved for
a capacity constrained monopoly airline firm. A particular advance purchase
discount policy is shown to be the profit-maximizing method to sell tickets,
diverting some demand from the peak period to the off-peak period. They
explain sales through the approach of inter-temporal discrimination between
heterogeneous consumers as well. A different level of "disutility to delay" in the
preference space is introduced to th at purpose. In the optimal direct revelation
mechanism, all seats on the peak flights are sold at high price to high-value-oftime consumers, while low-value-of-time passengers purchase the off-peak flight
with an advance purchase discount. This airline industry specific paper shows
an optimal mechanism th at provides a cheaper substitute product, i.e., the offpeak flight, to divert demand discriminatively. It can be looked upon as a
form of sale10, and in particular, their way of incorporating consumers timing
cost to the utility is shared with my dissertation. My model though, lack of the
capacity constraint incentive, predicts a diversion from peak demand to off-peak
as well. And the incentive is to inter-temporally price discriminate for higher
joint profit.
10Though this is not in a traditional sense of sale, as a direct price mark down.
16
1.2.3
P rice D iscrim in ation w ith M u lti-d im en sion s or C om
p etitio n L iterature
Besides the sales literature, work on price discrimination is also pertinent
to my dissertation, especially in the following two directions. One branch is
price discrimination in multi-dimensional preference space. Armstrong (1996),
Armstrong and Vickers (2001) and Rochet and Stole (2002) are examples of this
work. The other direction relevant is in price discrimination with competition,
which is the main literature resource for my oligopoly chapter.
A common
argument on this topic is th at distortion will disappear when the market is

competitive enough. The basic ingredient is th at the need to compete will
dominate the benefit from screening when the market competition is intense.
My result is in line with this argument.
Armstrongs paper (1996) on multi-products nonlinear pricing extends
the dimension of monopoly price discrimination problem, by employing a very
general form, multi-unit demand, multi-product and multi-dimensional prefer
ence. In his preliminary exploration of the larger problem by following the
classical mechanism design approach, he finds two main results. First, in a
multi-dimensional preference space, the monopoly finds it optimal to exclude
some low demand consumers from the markets. This exclusion is due to the
convexity in the multi-dimensional preference space, so that under a small price
17
increase, the exit of low-demand consumers is outweighed by the gain from

the participating consumers. The other result is a method using multi-variants
form of "integration-by-parts" to solve the problem for a class of cases. This
special class involves separation in the form of consumers value function as
well as preference distribution function. Otherwise, a closed form solution is
impossible.
I use discrete valuation instead of continuous valuation with a continu
ous timing distribution in the preference space, to avoid the convexity and the
exclusion. Therefore, though my Hotelling style utility function is not multiplicatively separative, I still obtain a closed-form solution by the IC and IRs.
Armstrong and Vickers (2001) propose a new way to analyze multi
dimensional price discrimination.
They transfer the multi-dimensional pref
erence space to a single dimensional utility space, thus circumventing the com
plicated examination through costs, price and output. Under this construction
the equilibrium outcome depends directly on ir(u), the profit of firms competing
by providing utility to consumers. They examine the profit, utility and welfare
implication of price discrimination policies in an oligopoly market structure.
A Hotelling horizontal model is used to capture competition. They separate
the analysis into three categories, with homogeneous, observable heterogeneous
and unobservable heterogeneous consumers. For unobservable heterogeneous
consumers, who have independent, private, product-specific information about
18
their tastes, if the market is competitive enough to cover all consumers par
ticipation, there exists an equilibrium where firms offer cost-based two part
tariff. In particular, there is no screening and all consumers face the same mar
ginal prices. This is because the need to compete dominates any benefits from
screening consumers.
Rochet and Stole (2 0 0 2 ) examine nonlinear pricing with random partic
ipation by introducing a stochastic reservation value along with an unknown
valuation of quality in the consumers preference space. They obtain a novel re
sult different from the classical paper of Mussa and Rosen (1987), by employing
a direct revelation mechanism. The familiar "no distortion at the top" result
persists, but there is either no distortion at the bottom or bunching. The intu
ition is th at when the variance of reserve value is high, the monopolist finds it
more effective to set quality efficiently, or to price lower uniformly for high and
low valuation consumers, in order to increase market penetration. Encouraging
participation outweighs extracting higher rents from high-valuation consumers
by distorting quality, or charging higher price. They also look into the price
discrimination in a duopoly competition. As in Armstrong and Vickers (2001),
they apply a standard Hotelling model with lump sum transportation cost. In
the symmetric case, when the transportation cost is small enough to cover of
the whole market, distortions disappear and the equilibrium takes a linear form:
efficient quality allocation with cost-plus-fee pricing.
19
Katz (1984) explore price discrimination and monopolistic competition by

employing a different kind of competition relative to the more frequent Hotelling
horizontal differentiation. Assuming informed and uninformed consumers, a
price dispersion in an N-firms market result is obtained, consistent with Varian
(1980). He further assumes that uninformed consumers make small purchases,
and informed consumers make large purchases, as in Salop and Stiglitz (1982),
which leads to a nonlinear pricing with respect to sale quantities. Katz shows
that the unique equilibrium is a symmetric equilibrium where all firms engage
in an efficient quantity discount nonlinear pricing. Furthermore, if the portion
of uninformed consumers is large, then price discrimination delivers a more
efficient production allocation than the uniform price regime and vice versa.
When compared to the price discrimination literature, my model agrees
with Mussa and Rosens classical result of "no distortion at the top, distortion
(bunching) at the bottom". The oligopoly competition result is consistent with
Armstrong and Vickers (2001), Rochet and Stole (2002) and Katz (1984) in
the respect th at a market intensely competitive could correct the distortion to
an inefficient discrimination. In the model, I assume both loyal and non-loyal
consumers, to maintain a certain degree of monopoly power to the firm, an
assumption similar to K atzs informed and uninformed consumers, and different
from Armstrong and Vickers (2001), and Rochet and Stole (2002)s Hotelling
model.
20
C hapter 2
M onopoly M echanism D esign

I begin by assuming a monopoly market structure with a single product
and explore the firms best sales strategy. Due to the nature of different types
of products and motivations of a firms sale behavior, I separately consider two
categories of products, everyday goods and holiday goods in the following two
sections. Everyday goods are characterized by a stable demand over time, so
that consumers preferred consumption time is evenly distributed on the infinite
time line. Holiday goods, in contrast, have a very low, if not zero demand
during the off-season, and a jum p in demand on the holiday. Hence, consumers
preferred consumption time mass distributes on the holiday time for these kind
of goods.
2.1
T h e M o d el
21
A homogeneous product market with zero marginal cost is assumed. Con

sumers make either a one unit or zero unit purchase. There are many goods
with the unit-purchase property, for instance, durable goods, movie tickets, and
large packaged groceries. Each consumers characteristic is captured by a dual
(9,t). 9 is the type of a consumer, according to his valuation of the product.
I assume 9 {H ,L }, and H > L. t denotes the preferred consumption time.
If the purchase is made before or after the preferred consumption time, a stor
ing cost or postponing cost is incurred, which is the product of a unit cost ce
and the timing distance. I assume the H type consumer is more impatient,
i.e., cH > cL.
The dual characteristics (9,t) are private information to each
consumer and arbitrage can be prevented by the firm.

In the game, each consumer reports his type and preferred consumption
time (9 ',t'), and the firm assigns him a purchase schedule {P (9r,t'),X (9 '
P (9',t') is the price charged for the good and X (9',f!) is the purchase time
accordingly. Thus, a consumer (9,t) who reports (O'. t') will get the utility:
U (9\ t'\9, t) 9 P(0', t') - c 9 x |X (9', tr) - t\
(2.1)
This utility function is analogous to the Hotelling model with linear transporta
tion cost, with the axis denoting timing instead of geographic location.
This model aims to derive the sales pattern a monopoly firm will design
and the equilibrium oligopoly firms will reach. Conventionally, a sale means
22
a price reduction that firms employ in order to attract new consumers and/or
encourage selling vohime. For the purposes of this paper, a firm is said to hold
a sale when it sells to L type consumers: the price is at its lowest and quantity
sold jumps up. This is consistent with most conventional ideas of a sale.
Some assumptions on the parameters of the model setup follow.
A ssu m p tio n 1 For simplicity, I assume the numbers of the H type conswners
and the L type consumers are same fo r everyday good model.
A ssu m p tio n 2 Parameter assumptions: H < 2 L and cH > AcL.
Assumption
can be easily extended and modified, and Assumption
is
required technically for the proofs.

Intuitively, Assumption 2 rules out two scenarios in which an inter
temporal discrimination would not be obtained. One case is when H
L,
there is too large difference in the reserve prices, so that the firm would ignore
the L type completely and serve the H only. The other case is when cH is too
close to cL, so th at there is not enough distinction in the disutility to timing
between the two types. As a result, consumers cannot be efficiently separated
inter-temporally . 1 The intuition of this assumption is reflected in the compara
tive statics analysis in Corollary 3.
C onsider an extreme case where cH = cL = c, and suppose the firm holds one sale at
{ P x , x } . If ( L , t ) participates in the sale event, which means L P* < L P x c * \t x\,
then (H , I) will also participates, since H P l < H P x c * \t x\. In this case the two
types cannot be inter-temporally separable at all.
23
Based on the Revelation Principle, telling the tru th is always the domi
nant strategy. Therefore, I restrict my attention on the direct revelation mech
anism design problem. W hat follow below are the individual rationality con
straints (IRs), equations (2.2) and (2.5), and the incentive compatibility con
straints (ICs), equations (2.3), (2.4), (2.6) and (2.7). Equation (2.3) and (2.6)
are inter-ICs, which means th at a type will not mimic the other type. Equation
(2.4) and (2.7) are intra-ICs, which ensure th at a member of a type will not
mimic other consumers within the same type, with a different t. This direct
revelation problem can be restated as a truthful implementation problem for
the firm: the firm announces an incentive compatible purchase schedule over
time {P (d ,t),X (9 ,t.)}, 6 E {H ,L }, t E (oo, +oo) and consumers choose the
best bundle upon their utility maximization.
For the L type:
( 2 .2 )
(2.3)
(2.4)
For the H type:

(2.5)
(2.6)
24
U(H, t\H, t) ^ U(H, t'\H , t) for all t'
2.2
(2.7)
A n a ly sis o f E v ery d a y G o o d s
Due to the nature of the everyday good, t has a constant distribution

density function. I normalize f(t ) = 1, for t (0 0 , 0 0 ), where f (t ) is the
density function of t. This assumption means the demands from both types are
stable along time. This allows for infinite one-time purchase consumers evenly
distributed on the infinite horizon time line, or, alternatively, finite consumers
with multi-entry into the market, but with their preferred consumption timing
being evenly distributed. To fix ideas, such a homogeneous everyday good could
be as diverse as bread or iPods. Everyday thus connotes an even distribution
of purchase over time, in contrast to the spike in demand that products like
school bags or Christmas toys are characterized by. Examples of monopoly sup
pliers of everyday goods are Apple, as maker of iPods and Disney, as distributor
of its sole-licensed DVDs.
This section focuses on predicting the sale patterns of a monopoly firm.
To th at end, I first show th at the firms sales timing mechanism falls into a spe
cial category in terms of the purchasing time of consumers, namely, separating
in H and pooling in L. This is proved through Lemma 1 to Lemma 3. After this
filtering, Proposition
and 2 derive the optimal mechanism for the monopoly
25
firm selling an everyday product.

L em m a 1 For the sale schedule provided to the L type, { P ( L , t ) , X ( L , t ) } ,
X( L. t) must be a discrete mapping with respect to t. To be exact, fo r any t
such that X ( L , t ) = t, there exists e > 0, such that for any t' G [t e ,t + e\,
X{ L, t ' ) = t.
Please see the appendix for the proof. Intuitively, Lemma 1 says that
a sale can only happen discretely and cannot last for an interval. Scattered
sales events can optimally discriminate different types of purchasers. This result
derives from the model assumption th at consumers are fully informed about the
firms price overtime. We often see "one-week" or "one-weekend" sales, which, in
my opinion, are approximations to the model result with incomplete information
and other reality noise. Further, it is easy to prove that if X (L , t) = t. then
X( L, t ' ) = t for any t! [t - I, t + /], where I = L~r~ ' This states th at two
adjacent sales will not be placed less than 21 apart, which defines a sale cycle.
The incentive for a price reduction is thus proportional to the length of time
since the last sale, and this is also an im portant result found in Sobels papers.
Lem m a 2 I f t \ and t 2 are two adjacent sales, then there must exist t* [fi, 2 ];
such that
U(L,t*\L,t*)
= L - P ( L ,tx) - c L(t* - h )
-
L - P ( L , t 2) - c L(t2 - t * ) = 0
26
P ro o f. Contradiction is used to prove this lemma. Suppose all L types

between t\ and t2 have strictly positive utility, then the firm can raise both
P(L, ti) and P(L. t2) a little bit and extract more surplus from both H and L
types. The IR condition for L type consumers simply guarantees their partici
pation. Thus there should not be any L types with strictly negative utility in
between.
Lemma 2 guarantees the "just-coverage" of the whole market, i.e., sales
should just cover all the L type consumers. All consumers participate in pur
chasing, and there exist some marginal L types who locate just in the middle
of two sales and earn zero utility.
L em m a 3 For the selling schedule for the H type, {P(H, t), X ( H , t)}, X( I I , t)
must be a continuous mapping with respect to t. In addition, X ( H , t ) = t for
all t.
P ro o f. See appendix.
This lemma shows the "no-distortion-on-the-top" result for I I type con
sumers. Whenever an H consumer wants to buy the good, the firm immediately
sells to him, without any delay or storage.
P ro p o s itio n
In the optimal mechanism design for a monopoly firm, every
consumer makes a purchase with the schedule {P(H, t), X( I I , t ), P(L, t ) , X ( L , f)},
X ( H , t ) = t. Let X ( L , x ) x, then X ( L , t ) = {x, x + 2l, x + 4 1 , where
I = k~pJ L't) f and p ( L , t ) is constant fo r all t.
27
P ro o f. From Lemmas 1-3, we know X ( H , t ) = t, X ( L , t ) is discrete,

and sales just cover the whole L type consumers. So, we can define the sale
interval, 2I, a measure of the number of L types th at participate in a certain
sale at t. I = X-PjL'l). I is a function of P ( L , t ) only. We then define a unit
sale profit function, tt(7), which is the profit from both H and L located on
[t l,t + I]. Then denotes the average unit sale profit. Since demands are
evenly distributed on the infinite timing horizon, once the monopoly firm finds
the I and P(L, t) to maximize
it is optimal to repeat this cycle forever. The
unique I and P(L, t) will be derived in Proposition 2.

Proposition 1 summarizes the "no-distortion-at-the-top and distortionat-the-bottom" result from Lemma 1 to 3, which is illustrated in Figure (2.1).
This result is analogous to a standard price discrimination conclusion, but is
derived with respect to a purchase timing allocation, instead of a quality or
quantity provision . 2 The proposition also shows that in the optimal sales, H
types may purchase whenever they need, whereas L types can only purchase
through the scattered sales events, in other words, a separating strategy for H
and pooling strategy for L in terms of purchase timing assignment by the firm.
It is the variation in patience on the part of different types of consumers that
leads to the success of this price discrimination.
I now derive the optimal mechanism {P(H, t ) , X ( H , t), P ( L , t), X ( L , f)}
2In this case, the distortion is not in the same direction across types. Some consumers
need to store and some need to postpone. "Bunching at the bottom" is a more accurate term.
28
Figure 2.1: Purchase Time Distortion
X(H,t)=t
X(L,t)
F o rL
For H
X,
and the interval between sales,
21,
given the parameters
H ,L ,c h ,cl
and the
unit density distribution of t, by maximizing the monopoly firms unit profit

function:
(2 .8)
P( H, t ) , P ( L , t )
subject to ICs and IRs. Proposition 2 establishes the result.
P ro p o s itio n 2 The optimal sale mechanism for a monopoly firm is

{P(H, t ) , X ( H , t), P(L, t), X ( L , t ), I}:
Let X ( L , x ) = x.
X ( L , t ) = x + 2l * i , i is any integer that minimizes {\t x 21 *i\};
P( H, t ) = P( L, t ) + cH\t - X{L, t)\,

ift<E [X(L , t) - h, X (L , t) + h\ ;
29
h _
H -P(L,t) .
cH
P( H, t ) = H,
if t e [ X { L , t ) - l , X { L , t ) - h ] o r t e [X(L,t) + h , X ( L , t) + I].
and X ( H , t) = t.
P ro o f. See appendix.
The sale price P(L, t) is the key variable determining all other variables,
such as the non-sale price and the sale cycle. Figure (2.2) illustrates the sale
pattern predicted by this model. The interval between [1,1} is one sale cycle.
The length of this interval is decided by the duration required to just clear
L type entirely in the market. W ithin a cycle, the price starts as high as H
types reserve price, then gradually reduces, until the lowest point, where a sale
happens. L type consumers are cleared at the sale event. After the sale, price
goes up, to H again. The sloped area is on the inter-IC of H types, to guarantee
that they will not mimic L and take the sale. The monopolists best strategy is
to repeat this sale cycle infinitely.
The following three Corollaries show the comparative statics of the sale
price, sale cycle and firms unit profit in terms of the parameters, H , L, cH and
cL.
C o ro lla ry 1 For the sale price in the optimal mechanism, dPQ ^ < 0,
0, ^
> 0, and s a u i < 0.
>
30
Figure 2.2: Monopoly Everyday Good Price
P(H,t)
-H
(L,t)
The sale price is lower as the gap between H and L types valuation
increases, and higher as the difference between their impatience level, increases . 3
C o ro lla ry
For the sale cycle in the optimal mechanism, Mr > 0, M- < 0,
IFF < O IFF < 0 a n d d(H -L) > -
The sale cycle is positively correlated to the valuation gap, and negativelyrelated to the impatience. W ith the unit purchase and full participation con
straints, the only factor affecting the social welfare is the timing cost associated
with postponing and storing consumptions. The sale cycle captures this social
welfare loss.
To be exact, \c L * I is the unit welfare loss. It is easy to show
-U i-
n dhcL*l
that
> 0,
,,
< 0,
dhcL*l,
A d i c L*l
< 0,
_, d \ c L*l
rr,,
> 0 and d(~

H._L) > 0. Therefore,
the larger the valuation distinction, H L, the longer is the sale cycle, and the
3( H L ) increases by lifting H and/or lowering L. Samely, (cH cL ) increases by enhancing
c 11 and/or reducing cL .
31
lower the social welfare. The more impatient the H types, the shorter is the sale
cycle, and the higher the social welfare achieved; however, the more impatient
the L types, the shorter is the sale cycle, and the less the social welfare achieved.
C o ro lla ry 3 For the firm s unit profit n in the optimal mechanism, > 0,
The firms unit profit is increasing in the valuation of the two types. And
the more different the two types patience, the more profit the monopoly could
obtain through a discrimination pricing. This is consistent with the intuition
behind Assumption
in the previous section, which restricts patience levels
distinct enough for a successful discriminative pricing.

CGS (1984) and Sobel (1991) analyze models of timing of sales for a
durable good monopoly. In their models, consumers differ in terms of their
valuation of the good, and they enter the market at discrete time points consis
tently. Under a noncommitment setup, a cyclic pricing equilibrium is obtained
due to the constant inflow of new consumers. The monopolist, from time to
time, offers a sale to cater to the existing pool of low-valuation buyers. For
a few periods, he charges high prices so as to extract the surplus from highvaluation buyers, until the proportion of low buyers in the stock of unserved
customers becomes so high that he cannot resist selling to them at a lower price.
The assumption of continuous inflow of consumers, however, could not support
a cyclic pricing pattern with a committed monopolist. Sobel shows th at no
32
strategy could provide a higher profit for a monopoly firm than setting his price
equal to H or L types reserve prices.
W hat then contributes to the inter-temporal price discrimination in an
optimal strategy? The answer lies in the different levels of patience, among three
parties, H type consumers, L type consumers and the firm. CGS (1984) and
Sobel (1991) impose an equal discount factor common to both types consumers
and the firm, while in my dissertation, all the three parties are assumed with
different levels of patience: the firm is with zero discount factor, and cH > cL.
The different levels of consumers disutility to timing provide the channel for
the timing discrimination. Patient buyers get the best deal. This cyclic pricing
scheme can be sustained when the symmetry of the storing cost and postponing
cost is loosened. This model can incorporate Sobels asymmetric timing cost
structure by assuming an infinitely large storing cost and an exponential post
poning cost, which accounts for the inability to land on the market beforehand
and discounting once in the market. Heterogeneous discount rates are essential
in deciding the cyclic pattern. Restricting an equivalent patience level between
the consumers and/or introducing an impatient seller in my model result in
noncyclic pricing, and allowing for heterogeneous discount factors in Sobels
model may support a cyclic pricing in a mechanism design. A formal analysis
is contained in A.2 in the appendix.
In an empirical context, besides a direct price discount, there are var
33
ious other sales strategies implemented to discriminate consumers with dif

ferent patience.
Coupons and rebates are examples of these.
Coupon and
rebate collection and redemption are time consuming. Low type consumers,
with low search cost and more patience level would engage in a purchase with
coupon/rebate while high type consumers might not find it worthwhile. In-store
coupons/rebates are another form of price deduction, and consistent with the
models prediction, they are available cyclically. There are coupons/rebates
that are only available upon registration to the manufacturers website, or
enrollment to ad mailing list.
Filling out forms and similar procedures are
involved to increase the time cost in discriminating different consumers noncontemporaneously. Hence, this type of coupons/rebates are accessible all the
time, which is also consistent with the model.
2.3
A n a ly sis o f H o lid a y G o o d s
In this section, the objective is to derive the sale pattern of a holiday good
or seasonal good. Such a good is characterized by an extremely low demand
during regular time, and a sudden spurt in the holiday season or other events.
This implies a mass distribution of t at t = 0, assuming the holiday occurs
at time 0. There are numerous products falling in this category, for instance,
Christmas trees and swimwear.
34
In contrast to the case of everyday products, the firm knows the timing
distribution location of all consumers exactly (t 0 ), and can thus perfectly
separate the two kinds of consumers in the optimal strategy. For holiday goods,
I relax the assumption of an equal number of H and L type consumers, to enable
a more general analysis. Instead, a proportion of the total customers are L, and
1 a are H types.
W ith a zero cost assumption, the monopoly firms objective function is:
m ax(l a)P(H, 0) + aP( L, 0)
(2.9)
subject to ICs and IRs. We can replace t with 0 in the equations (2.2)-(2.7).
L em m a 4 In the optimal strategy for the H type, {P(H, 0) , X( H, 0)}, X ( H , 0) =

0, i.e., H types always purchase on the holiday.
P ro o f. The simple proof obtains from the following arguments. Suppose

X (H , 0) 7 ^ 0 in the optimal strategy, then the firm can always increase both
P(H, 0) and P(L, 0) while decrease \X(H, 0) and \X(L, 0) |, earning more profit
from both types while keeping the participation and incentive constraints.
L e m m a 5 In the optimal sale strategy, IR for L and IC for H must bind.
P ro o f.
1 ).
Suppose L earns positive utility with {P(L, 0), X (L , 0)}, then
the firm can simply increase P(L, 0) while still guaranteeing the participation of
35
L, and enforcing the no mimicking condition for H. Thus, the firm can extract
more profit from L. This step shows th at IR for L binds: L P(L, 0) cLt = 0
2). Suppose H is strictly better off choosing non-sale {P{H, 0), 0}, then
the firm can shrink \X(L, 0)| and increase P(L, 0) at the same time. Since the
H type values purchase timing more, there exists, on the I R of L, a unique
price-time pair that generates the same level of utility for H as he purchases
on the holiday.
Hence II does not have an incentive to mimic L, and the
firm can earn more profit from L. This step shows that inter-IC for H binds:
H - P(H, 0) = H - P ( L , 0) - cHt. u
P ro p o s itio n 3 The monopoly firm will play either a separating or a pooling

strategy in terms of purchase timing assigned to different types of consumers,
{P(H, 0), X ( H , 0), P(L, 0), X( L, 0)}. In particular, if a ^
a, separating
result is played: P(H, 0) = H\ X ( H , 0) = 0; P{L, 0) = cHJ r ~ r -; X ( L , 0) =

ch ZcL I f a > ~ j f ~ , a pooling result is achieved: P(H, 0) = P(L, 0) = L \
X{II, 0) = X ( L , 0) = 0.
This proposition follows directly from the profit maximization problem

conditional on Lemma 4 and 5. Figure (2.3) illustrates this sales pattern. When
the population of L is small, a separating strategy is used. During the holiday
or the peak season, price is as high as the H consumers reserve price, and only
H types make purchase. L types can obtain the product through either the pre
season or the post-season sale located at x and x. Perfect information about
36
Figure 2.3: Monopoly Holiday Good Price

P
L--I
the timing distribution of consumers endows the firm with higher market power
to optimally extract profits from both types. In contrast, when the population
of H is small, inter-temporal discrimination is not efficient. The firm cares more
about extracting profit from L. Therefore the firms would not engage in any
strategy th at distorts L types purchase. In this case, everyone purchases on the
holiday at a price equal to L. In the pooling result, the H types are left with a
positive rent, while in the separating result, both types of consumers earn zero
utility. The right-side panel of figure (2.3) illustrates the determination of the
separating sale schedule {P(L, 0), X ( L , 0)} through the indifference curves of
consumers. The shaded area is the discrimination area that L types would take
while H types would not, and the bold segment is the sale frontier on which
the firm chooses to maximize its profit. Optimal { P ( L , 0 ) , X ( L , 0 ) } is decided
accordingly.
Form Proposition 3, the larger is the difference between the patience
37
level of H and L, the more likely a separating result is played. This is again
consistent with the intuition behind Assumption 2: it is easier to discriminate
the two types inter-temporally with more distinction in their patience. The
social welfare in the separating result is increasing in
since less timing cost
is needed for the discrimination .4

In reality, we observe either the prevalence of a pre-season sale or a post
season sale for a specific product. It is unlikely that a consumer would purchase
a Christmas tree post-seasonally. On the other hand, after-summer sales of
summer clothes are very popular. These variants can be easily incorporated
into the model by allowing different values for storing cost and postponing
cost .5
The separating result with pre and post sales can also help explain some
other inter-temporal discrimination phenomena without a special holiday or
seasonal effect involved.
It is commonly observed that popular books are sold first in hardback,
and they are reissued in paperback after several months. Varian (1997) addresses
this through a quality discrimination by versioning pricing. However, a quality
4This is due to the social loss equation:
\cl * X ( L , 0 ) \ = t L
~-
7F 1
5Let cH1 and cL1 be the storing cost and cH2 and cL2 be the postponing cost. For example,
by setting oo > > cHl > cL1 and cH2 = cL2 = oo for Christmas trees, a pre-season sale would
be the only tenable model prediction.
38
discrimination alone hardly explains the fact th at paperback versions are never
issued at the time the books are first released to the market. Considering that
both the cost and quality differentiation of paperback binding is only slightly
less than the hardback, I argue for an explanation through an inter-temporal
discrimination with consumers with heterogeneous patience. This holiday goods
model can justify this observation. Both H (less patient) and L (more patient)
type consumers prefer a consumption at the time the books hit the market (the
holiday time). And a separating result predicts th at H types purchase and
consume on the initial release time, with hardbacks, while L types purchase on
a post-season sale with paperbacks.
Similarly, movies are issued first for the big screen, and then released in
video after a couple of months. Apart from Vaxian (1997)s reasoning with a
quality discrimination, I support an interpretation using the inter-temporal price
discrimination as well. Noticing the fierce competition in the movie industry6,
I put a more detailed explanation in the Section 3.3.
6According to Liran Einav (2003), release dates of movies are too clustered, specially
on holiday weekends. Therefore an oligopoly analysis on movie-DVD releasing is more
appropriate.
39
C hapter 3
O ligopoly Sym m etric

Equilibrium
In this chapter, the sales behavior of firms in the oligopoly market is
analyzed. There are IV ^ 2 firms in the market. The firms are symmetric
in marginal cost, which is normalized to zero. The consumer reveals his own
characteristic (9 ',t'), and each firm j simultaneously assigns him a purchase
schedule, { Pj (9', t'), X j (8', ')}, j = 1,2, ...IV, based on the report. Consumers
then choose the best bundle among the offers from N firms according to their
utility maximization. If more than one firm proposes the same schedule for
some particular (L , t ), then they evenly share these customers. Again, assum
ing full commitment, I restrict attention to the direct revelation mechanism in
which truth-telling is an optimal strategy for each agent, as is consistent with
40
the monopoly case examined in the previous chapter. Therefore the IC and
IR conditions (equations (2.2)-(2.7)) in Chapter 2 apply here. The technical
Assumption
and 2 are required in this chapter for enabling the proofs.
H type consumers are assumed to be loyal in this chapter, in the sense

that they will purchase from a preferred store, without consideration to the
prices of th at store or of other stores, as long as the store price is below their
valuation. The loyalty of H types plays an essential role in the oligopoly equilib
rium. This loyalty could arise from H consumers lack of information on prices
or from spatial search costs being too high. Consistent with the assumption
of the H type being more impatient, H consumers are unwilling or unable to
go to more than one store for a best deal search. Each firm attracts 1/ N loyal
consumers in the market . 1
W ith an increase in the number of firms in the market, the loyal customers
become less important in comparison to the constant pool of L type consumers.
This is consistent with traditional view of "more firms, more competition in the
market". Yet, this even spread of the loyal customers over existing firms has
some drawbacks: upon an introduction of a new brand, there is a preference
switch among the loyal consumers . 2 I prove the results, adopting the Spokes
Model approach in Section A.3 of the appendix. Moreover, the Spokes Model
M he assumption of loyalty of H type consumers is employed in Sobel (1984) as well. This
concept is similar to the uninformed consumer in Varian (1980) and Katz (1984).
2Spokes Model in Chen and Riordan (2006) elaborates this process.
41
provides a natural H loyal customer generator, another way to understand the

loyal customer assumption.
3.1
This section delves into the symmetric equilibrium in firms sale strategy
for everyday goods. To tackle this problem, I divide the analysis into three main
steps. The first step is to decide whether separating in II type and pooling in L
type in terms of purchase timing is still the dominant strategy for firms in the
oligopoly scenario. The second step is to solve the pure strategy Nash symmetric
equilibrium. I then look into the most profitable collusive equilibrium in the
third step. An interesting result is th at a collusive equilibrium with joint profit
exceeding the monopoly level can be achieved.
P ro p o s itio n 4 There does not exist an equilibrium such that X 3(L. t) = X 3' [L, t'),
j f , for all t, t!.
P ro o f. Suppose to the contrary, firm j and firm j! hold sales together:

X 3(L,t) = X 3(L, t) = t.
WLOG, if P3(L. t) > P 3'(L,t), then firm j t gets all L types. Firm j
should then either charge P 3 < P 3'( L ,t) in the sale or let P 3 = H , drop the
sale competition.
42
If instead P 3(L, t) = P 3' (L, t), then each firm attracts half the population
of L. Both firms have an incentive to lower the sale price a little bit to get all
L types and earn almost twice the profit from L. This is exactly the same logic
as is used in Bertrand competition. The result is th at both firms would end up
charging a sale price P j ( L , t ) = P 3'(L,t) 0. Firms earn no profit from sales
and also lose profit from their loyal customers. They would find it better off to
stay out of sales by charging H given others decision.
Proposition 4 states that there does not exist an equilibrium with two or
more than two firms holding sales at exactly the same time. This significantly
relies on the loyal H type consumers assumption. The loyalty retains each firm
a monopoly power over the H types, which guarantees a positive benchmark
profit level. W ithout this benchmark profit choice, there is nothing to prevent
prices from falling to zero. This Bertrand logic proof rules out the absolute
symmetric equilibrium, in which all firms pursue the common strategy: the
same { P3{H,t), X 3{H,t), P j { L , t ) , X 3(L,t)} for all j , t.
L em m a
For the equilibrium selling schedule for H type from each firm,
{ P3(H,t), X 3(H, t)}. X 3(H,t) must be a continuous mapping with respect to

t, for all j . In addition, X 3(H, t) = t for all j , t.
P ro o f. Due to the loyalty of H consumers, each firm maintains monopoly

power with respect to them. In the proof of Lemma 3, a dominant strategy
X (H , t) = t only relies on the no-competition on H , therefore, the proof of this
43
lemma is same as the proof of Lemma 3 in the appendix.

For the selling schedule for the L types from each firm, { P3(L, t), X J(L, t)},
Xi ( L, t ) may not be discrete mapping with respect to t. A pooling sale may not
be sustained. And this correlates with the level of competition in the market.
If A' oc, which is a complete competitive market, at any time, for each firm
the number of loyal consumers goes to zero. Each firm cares only about the
L type consumers and any inter-temporal price discrimination cannot be sup
ported under the fierce competition. A Bertrand result 3 is the only equilibrium
in this market. While the results hold for N approaching infinity, it is also the
case th at for a sufficiently large N, the importance attached to competing for
the L type would dominate the benefit from exploiting profit from a small pool
of loyal customers. Thus, firms would enforce a separating strategy for L. The
next lemma proves these statements and find the critical N th at determines
whether it is separating or pooling for L in the induced purchase timing.
L em m a 7 There exists a critical number of firms in the market, N ^ H~p^L p^,

where P =
/ such that if the number of firms N > N , X'f(L, t) = t for all
j , t, a separating selling is provided to L. On the contrary, if N < N , sales are

scattered, i.e., for any t. such that X^{L, t ) = t, there exists s >
, such that for
any t' [t e, t + e], X^(L, t') = t.

3In this unique Bertrand competition, P ( L , t ) = P ( H , t ) = 0 , X ( L , t ) = X ( H , t ) = t , for
all t.
44
The details of the proof are in the appendix. Conditional on Proposition

4, Lemma 7 shows th at when the number of firms is small enough, firms behave
similar to a monopoly in terms of discrete sales. This is because of the fact
that the loyal consumers account more in the profit maximization. This result
agrees with the previous findings in Armstrong and Vickers (2001) and Rochet
and Stole (2002), both of which papers employ a Hotelling model to capture
market competition. They argue th at when the transportation cost is small
enough to cover the whole market, the need to compete dominates the benefit
from screening. In my model, firms face the same dilemma, competing for L
customers versus distorting L customers purchase time. When the degree of
competition increases, the former concern dominates the latter.
Next, I derive the symmetric equilibrium of selling strategies under this
oligopoly market structure. Lemma 7 states that we cannot unconditionally
simplify firms selling strategies as separating to H and pooling to L with respect
to purchase timing assignment. Therefore, we restrict our analysis to a less
competitive market in this section, in the sense th at the number of firms N is
smaller than the critical N, so pooling in L types purchase timing is guaranteed.
Proposition 4 tells us th at the absolute symmetric equilibrium in which each
firm behaves in the same manner at each time point does not exist. Hence we
concentrate on a more general concept of symmetric equilibrium, namety that
if any firm holds a sale, the sale strategy, including the sale price and sale cycle,
45
remains the same, i.e., { P3( L, t ) , P} is invariant for each firm j on sale.
P ro p o sitio n 5 When N < N =
where ? =
23
- ^ > there exists
a unique open loop Nash symmetric equilibrium in terms of the sale strategy
{P3(L, t). I3}, P 3(L. t) = P* and 13 = I* for all j . In addition, P* = y j ncji H
^ cl->
/
I* =
p # \2
2 Nchp*
Between any 21*, there is one and only one firm offers a sale, and
no firm can hold two sales in a row.
The proof is in the appendix. P* denotes the equilibrium sale price and
I* is half of the equilibrium sale cycle. {P*,l*} are uniquely determined by
two restrictions. One is the benchmark profit requirement, which means each
firm earns the same level of profit as the full rent from loyal customers in a
non-sale period, as the consequence of competition. The other restriction is no
unilateral deviation, which means given others strategy, no firm would deviate
from {P*, I*}, if it is its turn to hold a sale.
An example to illustrate this equilibrium is given in figure (3.1). Two
firms, j and jr are assumed in the market, denoted by the red and black schedule
respectively. And they must alternate in holding sales in the equilibrium. L
types are cleared at the sales events when price reaches P*. The sloped area
is on the H types inter-IC, assuming firms full commitment to price. When
it is firm j's turn for a sale, firm j f simply charges H , fully exploiting its loyal
consumers. Given the others pricing schedule, no one can deviate profitably.
46
Figure 3.1: Oligopoly Everyday Good Price
Why, in equilibrium, do both firms earn the same profit, equalling the
benchmark profit? Again, Bertrand pricing competition accomplishes the proof.
Suppose the sale firm j f earns higher profit than the benchmark, at [I*, I*],
then the non-sale firm j would profitably deviate by holding a sale at
with a
slightly lower price P* s. Only when firm j s sale profit on [P, I*] generates
the benchmark profit, is the best response of firm j to charge H on [I*, I*}.
W hat are the potential incentives driving a deviation from
for
firm j f at time 0, given firm j ' s strategy of staying non-sale? For a fixed I*,
firm j f tends to raise the sale price to exploit more profit from both H and L
consumers. This profit effect is monotonically decreasing with respect to the
sale price of firm jf. Firm j f has an incentive to lower the sale price as well, to
attract more L type consumers originally attending the neighbor firm j s sales.
47
This business stealing effect is increasing with respect to the sale price of firm
jf. P* balances these two incentives: Above P*, the business stealing effect
dominates, and firm j f prefers a lower sale price. Below P*, the profit effect
dominates, and firm j f tends to raise the sale price. Since it is the neighboring
sales that entail the business stealing restriction, in this equilibrium, firms must
alternate in holding sales.
In an N firms game, the identity of the firm offering a sale is irrelevant
as long as no one holds two adjacent sales. This model assumes homogeneous
product and symmetric costs for firms, for simplicity to show the basic intuition
behind firms sales behavior. One drawback is that the identification of the firm
offering a sale has to be determined outside of the model. In this case, store
culture m atters a lot. Usually, we observe th at some of the local stores in the
neighborhood offer sales frequently and aggressively, while some others rarely
lower their prices. The model predicts several sales features. W ithout seasonal
effects or supply fluctuations, stores do not coincide on sales, and stores must
alternate in taking sales slots.
From P* =
jfcH+cL
411
Proposition 5, the equilibrium sale price P*
is a decreasing function with the number of firms N . And when N = 2, it

can be proved that P* is lower than the monopoly sale price P(L. t) given
in Proposition 2, under the parameter Assumption 2 .4 The equilibrium sale
4When N = 2, P* =
F rom Proposition 2, P ( L , t ) = L -
P * < P ( L , t) based on Assumption 2.
~ L) .
48
cycle /*, however, is not necessarily shorter than the monopoly sale cycle in
Proposition 2. Competition is reflected through a price war, instead of the
length of the cycle. Hence the social welfare, which is determined solely by
social timing cost, a function of sale cycle only, is not clearly higher or lower
than the monopoly.
The last task in this section is to derive the most profitable collusive
equilibrium, in which firms agree on a price schedule {Pi{9, t), X j (9, f)}, j =
1,2
, ...N over time. Once a firm deviates from the agreement, the game goes
back to the competitive equilibrium described in Proposition 5 with one of the

punishing firm starting the first {P*, I*}. As long as the collusive price schedule
gives profit higher than the benchmark profit, a Nash collusive equilibrium can
be supported, due to the infinite time horizon and the non-discounting firms
assumptions here.
Under the homogeneous product and symmetric firms assumptions, gen
erally the highest joint profit attained in collusive strategies is the monopoly
level, decided by Proposition 2. And this profit level could be achieved by having
all firms coinciding their selling schedules and evenly sharing the H and L types
consumers. To be exact, firms agree on { P^ ( 9 , t ) , Xj (d,t)} that is determined
by Proposition 2, for all j . Let us call this strategy A.
Can firms do better? In this model, the answer is yes. Consider the game
in which firms alternate in holding sales. Within one sale cycle, only one firm
49
holds a sale, attracting all the L consumers. Other firms remain at a high price,
H, selling to loyal customers only. Firms coordinate to take turns in holding
the sales. The identity of the sale firm could be decided by a random lottery
draw right before a sale cycle. Therefore, each firms expected profit complying
with this cooperative strategy is straightly greater than that from a deviation
and a following conversion to the competitive equilibrium. Thus this alternating
collusive strategy can be supported in the equilibrium. Further, this collusive
agreement, denoted as strategy B, obtains higher profit. Lemma
establishes
the result.
L em m a
The alternating collusive equilibrium with strategy B obtains higher
joint profit than the coinciding collusive equilibrium with strategy A, which pro
vides the monopoly level.
P ro o f. The joint profit from strategy A obtains from the optimization

of the following problem with respect to sale price P L. This is precisely the
monopoly problem as in Section 2.2.
7T
max p l ,i
max ~ { P Ll + l H + [
{PL + cHt)dt - h H ]}
where I = L [ - and h = H
C 1'
CM
50
The maximized joint profit under strategy B is:
m z x j { P Ll + l H + ^ { f
( PL + cHt)dt hH]}
J 0
where I = L~ [L and h = H~u'

Because [Jq ( P l + cHt)dt hH] < 0 , irB > tta . In words, the cooperative
strategy with alternating sales creates higher profit than the monopoly level.
The expected unit profit for each firm is ^
> nBenchmark =
therefore,
strategy B can be maintained in the equilibrium.

Alternating in holding sales further provides a device to discriminate
H types, and that is made possible because of their loyalty. In a sale event, in
return for the profit from L, firms forsake monopoly exploitation over H . Taking
turns in sales optimally extracts rent from both types. Due to the single decision
making process5 for the collusive strategies, this problem can be looked on as
a monopolist producing multi-products th at are close substitutes, for example,
with different colors or packages. H types are loyal to one of the products and
L types are indifferent. Lemma
argues th at alternating in offering sales for
the different products can be more profitable than coinciding the prices.
5Single decision means that the strategy {P J (0, t ) , X ^ { 6 , t,)} is decided by maximizing joint
profit only.
51
Again, this model predicts scattered and alternating sales events by dif
ferent firms in the collusive equilibrium, coherent with the Nash symmetric
equilibrium in Proposition 5. This coincidence of the predictions under both
noncooperative and collusive market enables a more flexible data requirement
in the empirical analysis. Most of the time, whether firms form some collusive
relationships or not is not observed. In one supermarket, pricing of different
brands of a homogeneous product could be driven by the competition between
the brand manufacturers, or decided for a maximal joint profit by the coordina
tor, i.e., the supermarket. Section 3.2 empirically verifies the models predictions
on scattered and alternating sales, which is robust under both competitive or
collusive oligopoly market.
A comment about the loyal H type consumer assumption is in order here.
One concern with the current assumptions is the prospect of loyal consumers
change of preference over new products introduction. When a new product,
the N + 1th brand, is introduced, there will be jV^ +1-) former loyal consumers
switching to the new brand. Loyalty, which is considered as consistent support
for a specific product, seems to conflict this scenario. I address this concern by
demonstrating that the Spokes Model can be applied as an alternative, with a
corresponding alteration of Lemma 7. W ith Spokes Model, the less competitive
market th at leads to a pooling result in purchase time for L types is a market
with sufficiently large numbers of firms. A more detailed analysis is found in
52
Section A.3 of the appendix.
3.2
E m p irical E v id e n c e from S u p erm ark et S can

ner D a ta
The purpose of this section is to verify the predictions of my oligopoly
everyday product model using empirical data.
3.2.1
D a ta D escrip tion
The data source used here is the scanner d ata from Dominicks Finer
Food database. The Kilts center at the marketing department of the University
of Chicagos Graduate School of Business makes these data available on its web
site. Dominicks Finer Food is a one-hundred-chain supermarket corporation
located around the Chicago area, Illinois. Approximately 9 years of store-level
data, collected on a weekly basis from 1989 to 1997 on the sales of more than
3500 UPCs (Universal product Codes) are available in this database. The panel
data set contains scanner price, quantity sold, sales indicator, product informa
tion, and store-level customer demographics.
Since Dominicks is the only supermarket in the data, I have to treat one
store as a market. Specifically, I choose the Dominicks at Joliet, Illinois, with
the following selection criteria: From the store list map, this particular store is
53
seen to be located in a separate area, with a lower population and supermarket

intensity as well as with a store history longer than 9 years. The oligopoly
competitors I consider are different brands for a homogeneous product. There
are some high valuation consumers who are loyal to a specific brand and some
low valuation consumers who pursue the cheapest deal.
Who is making price or sales decision? A consultation with the store
manager established that manufacturers play a big role in determining the price.
A co-movement in the wholesale and retail price found in the data further
corroborates this. Thus, firms that own different brands for a homogeneous
product schedule sales and compete for customers who visit the Dominicks at
Joliet.
Among the large variety of grocery goods, I choose bathroom tissue as
my focus product, mainly because of its nature as a relatively homogeneous
product. In addition, this product contains a smaller number of UPCs, 128, as
compared to over 500 for most drinks, food products and soaps. Among the 128
UPCs of tissues, I further clean the data, by ignoring the UPCs with a shorter
history in the data and/or with averagely small amount of sales volume. By
means of this screening, I preserve the top sellers with a long history in the
market. This selection of popular sellers also rules out the scenario of inventory
or clearance sales decided purely by the supermarket. A description of the final
data is in Table (3.1).
54
Table 3.1: D ata Description

Table 1: Data Descriptives
Variable
N
Mean
Std Dev
Minimum Maximum
WEEK
385
196.1065
115.3519
1
399
MOVE1
385 211.3818 485.5724
0
4439
P1
385
1.129665 0.127988
0.6
1.31
SALES!
385 0.205195 0.404369
0
1
MOVE2
385
121.4494 286.9337
0
2659
P2
385
1.123311
0.130341
0.59
1.31
SALES2
385 0.176623 0.381846
0
1
MOVE3
385
159.5922 77.50294
0
592
P3
385 0.451932 0.059912
0.25
0.59
SALES3
385 0.093507
0.29152
0
1
MOVE4
385
135.039
200.817
0
1507
P4
385
1.158651
0.090905
0.79
1.31
SALES4
385 0.218182 0.413549
0
1
MOVES
385
126.7818
181.6897
0
1782
P5
385
1.158037 0.091533
0.79
1.31
SALES5
385 0.223377 0.417051
0
1
MOVES
385 627.4961
1336.61
0
14705
P6
385 0.531835 0.067285
0.71
0.25
SALES6
385 0.205195 0.404369
0
1
MOVE7
385
124.0286 235.3243
0
2978
P7
385
0.51057 0.058191
0.25
0.66
SALES7
385 0.205195 0.404369
0
1
MOVE8
385
141.1195
244.992
0
2657
P8
385 0.513305 0.059431
0.25
0.67
SALES8
385 0.194805 0.396566
0
1
MOVES
385
104.4338 227.8734
0
2887
P9
385 0.522511
0.062309
0.25
0.67
SALES9
385 0.168831
0.37509
0
1
MOVE 10
385
155.5974 287.3522
0
3395
P10
385 0.509619 0.058063
0.25
0.66
SALES 10
385 0.174026 0.379625
0
1
FES
385 0.171429 0.377373
0
1
PSI
385 0.4909091 0.5005679
0
1
Brands Index:
1: Charmm's
2: Charmm's
3: Dominick's
4: Northern
5: Northern
6, 7. S. 9. 10: Scott
FES: festival indicator

PSI: previous sales indicator
PS 1=1 if previous sale is by Northern
=0 if previous sale is by Charmm's
55
3.2.2
R esu lts
From the model in Section 3.1, at least two predictions can be summa
rized. One is th at firms try to scatter sales. They tend not to hold a sale together
during the same week. The second forecast is the phenomenon of alternation.
Once a brand goes on a sale, the next sale slot tends to be occupied by other
brands. Those two predictions are robust under both competitive oligopoly and
collusive oligopoly analyses.
Figures (3.2) and (3.3) show the time series pricing schedule of differ
ent UPCs for tissue respectively.
Figure (3.2) illustrates the price series of
Charmins and Northern, two brands that are very active in sales. Charmins
and Northern are the top two sellers of bathroom tissue, based on their selling
volume. Both of them produce large packets (four rolls per pack) of 2-ply white
tissue. The figure shows they alternate in holding scattered sales slots. This
is perfectly consistent with the oligopoly equilibrium found in the last section.
Figure (3.3) shows that the five products of Scotts coincide in the sale strategy.
This agrees with that manufacturer plays a big role in sales decision.
To test for the scattered sales prediction, I run a simple OLS regression
of the price of one brand tissue on other brands sales indicator, a holiday
indicator and week number to control for the time trend. The result is shown in
Figure 3.2: Charmins versus Northern
p ric e serie s fo r d iffe re n t brands
i .:
i
0 .5
0. 6
0. 4
0.2
0
49
53
57
61
65
65
73
77
SI
85
S3
93
97
101 105 109 113 117 121
125 123 133 137 141 145
149
treefcs
Figure 3.3: Scott Prices
p ric e se rie s fo r S cott

0. 6
0.
0. 1
0.
0.2
0. 1
0
:1
65
69
72
77
SI
35
S9
93
97
1C1 103 109 113 117 121 125 129 132 137 111
115 119
seek
57
Table (3.2). The positive parameter estimates indicate th at one brands price
(Charmins) tends to be high when others hold sales. The estimate of sales4,
which is the indicator for Northern is especially of interest, since Charmins and
Northern are the two brands active in holding sales. This parameter estimate is
significantly positive. The insignificant estimate of the holiday indicator verifies
that bathroom tissue is a nonseasonal good and the negative estimate of week
number shows that tissue becomes cheaper over the nine year period considered.
Regressions are also done to test for the alternating sales prediction. I
regress the price of one brand (Charmins) on the sales indicator of Northern,
a festival dummy, week number and a previous sales indicator (PSI). This PSI
is set to be 1 if the previous sale is held by Northern, and 0 if it is held by
Charmins. Shown in the second part of Table (3.2), the estimate on PSI is
significantly negative, which indicates that Charmins is more likely to lower its
price after the sale event by Northern. In all, I conclude th at these reduced
form regressions show consistency with the model predictions of scattered and
alternating sales.
3 .3
58
Table 3.2: Regressions

Tabic 2:
R e g r e s s i o n 1:
V a r ia b le
E s t im a te
S t d . E rro r
I n te r c e p t
1 .1 7 1 8
0 .0 0 1 2 4
0 .0 2 1 6 9
SA LES3
0 .0 1 4 0 5
SA LES4
0 .0 2 8 5 9
0 .0 1 5 6 4
SA LES6
0 .0 2 0 7 8
0 .0 1 5 6 5
FES
0 .0 1 9 0 8
0 .0 1 6 7 3
W EEK
- 0 .0 0 0 2 9
0 .0 0 0 0 5 5 0 3
R e g r e s s i o n 2:
V a r ia b le
E s t im a te
S td . E rro r
I n te r c e p t
1 .2 3 0 0 1
0 .0 1 7 8 3
SA LES4
0 .0 0 4 7 2
0 .0 1 6 0 8
FES
0 .0 1 3 1 6
0 .0 1 6 3 3
W EEK
- 0 .0 0 0 3 7
5 .6 8 E - 0 5
PSI
- 0 .0 6 2 7 9
0 .0 1 3 5 5
Regression 1:
Regress pricel (Charmm's) on sales indicators o f Dominick's. Northern. Scott. Fes and week.
Regression 2:
Regress Pricel (Channin's) oil sales indicators o f Northern. Fes. week and a previous sales indicator.
59
For holiday good, t is assumed to have a mass distribution, at t = 0,

the seasonal/holiday event, a proportion of the total customers are L, and
I a are H types, who are assumed to be loyal. This section investigates the
pattern of sales of such goods when the market structure is an oligopoly. Firms
now know the timing locations of all consumers exactly, and thus can perfectly
discriminate the two types of consumers in the optimal strategy. Proposition
shows the unique Nash symmetric equilibrium. In the equilibrium, a benchmark

profit, Tihenrhmark Pff-H, is earned for each of the firm, holding a high price
equal to H, on the holiday and charging zero price for L type consumers through
pre-season and/or post-season sales.
P r o p o sitio n 6 In the symmetric equilibrium where each firm engages in the
same strategy { Pj (H, 0), X 3(H, 0), P j (L, 0), X :i(L, 0 )}, for a l l j , the unique equi
librium is:
P 3(H, 0) = H, X 3(H, 0) - 0, pi ( L, 0) - 0, X 3(L, 0) =
P ro o f. First, X j ( H , 0) = 0.
Suppose not, then H types prefer {PHH, 0) + cH * \XJ(H, fl)|, 0} than

{ Pj (H, 0), X J(H. 0 )}, and firms earn higher profit by proposing { PJ(II, ()) + cH *
\Xj (H, 0)|, 0}.
Second, P j (L, 0) = 0.
This is the result of the Bertrand price competition.
Third, inter-IC of H must bind: H P J (H, 0) H 0 cH |X J (L, 0) 0|.
60
Figure 3.4: Oligopoly Holiday Good Price
H
L
Pt=d
Suppose not, then each firm can raise P j (H, 0) and gain higher profit.
At last, we can set up firms problem: max
0), subject to the
binding inter-IC of H.
Therefore, PHH. 0) = H and X^(L, 0) = $ .
Notice that in the symmetric equilibrium in the oligopoly market, dis
crimination is guaranteed irrespective of the population ratio of H and L types.
Firms will anyway gain zero profit from the competition for the L consumer,
and will therefore optimally set a sale that will not affect the full rent extrac
tion from their loyal consumers, even if it is a very small pool. Figures (3.4)
illustrate the sale pattern that obtains here.
Because X^(L, 0) 44- is longer than the monopoly sale point X ( L , 0)
JaZcL >there are more waiting and postponing cost incurred, and this leads to a
lower social welfare in the oligopoly market. Consumers welfare does not vary,
61
comparing with the separating strategy of a monopoly seller, as both types

earn zero utility. The social welfare loss is at the expense of the supply side:
competition lowers sellers rent, equal to the amount of the welfare loss.
This model can naturally be applied to various sales phenomena in many
diverse industries. Here, I discuss two common cases from the movie industry
and the airline industry.
It is increasingly common for movie producers to announce the release of
a DVD version of a movie within a few weeks to several months of the release of
a movie in theaters and consumers can rent and view what are, in effect, usually
a cheaper substitute in terms of the average price per viewer. My model can
explain this theater movie-DVD rental paradigm as follows. Again, two types of
consumers according to valuation, H and L are assumed, with different waiting
cost level cH and cL respectively. H > L and cH > cL. Movie and DVD are
considered as a homogeneous product, delivering the same quality experience,
with different release times. Since everyone prefers to watch the movie once
it is available, all consumers should be distributed at the movie release date,
analogous to a holiday event. Applying the holiday good model, we know that
only H customers go to the cinema to view the movie at a higher price, while
L customers can obtain the product, by renting a DVD, through a later DVD
release time, i.e., the post-season sale. If the movie is a box office success, then
we can treat the producing company as a monopoly, otherwise, an oligopoly
62
market for holiday goods model is applicable. Either way, the sales patterns
predicted are similar.
In the airline industry, a commonly employed feature is th at of different
price rates for peak and off peak flights. Again, consumers can be separated into
two types, high valuation and low valuation ones with corresponding patience
levels. H types, in the model, have preference over particular airline companies,
and this decides their loyalty. This is also borne out by the empirical practice of
airline loyalty schemes, including points and miles for using a particular airline.
Since the demand for peak time air tickets is higher than the off peak, the
distribution density of consumers timing allocation is higher at the peak time.
An extreme case is of everyone being located at the peak hour. This once again
has the flavor of a seasonal/holiday good set-up. The storing timing cost is not
for storing the tickets, but having to fly in advance in this case. H type travelers
purchase the peak tickets with high price, while L types purchase the off-peak
tickets with low price, in what is analogous to the pre-season or post-season
sales. If the storing timing cost is treated as a cost associated with in-advance
decision making, then the pre-season sale is the advance purchase discount to
the L type consumers for a peak hour flight.
63
Chapter 4
M onopoly C om plem entary

P rod u cts Pricing
Chapter 2 explored the monopoly single product sales mechanism. A re
lated interesting and meaningful question is to explore monopoly pricing when
the firm provides two products. If the two products are perfectly independent
with respect to each other in terms of the demand and supply, we have no rea
son to predict any correlation in their pricing pattern. However, if the demands
towards the goods are dependent serially, we might expect some co-movement
or counter-movement in their dynamic pricing as well. In this chapter, special
attention is paid to complementary products. The question th at this chapter
seeks to answer is what the optimal price strategy for a firm offering complemen
tary products is. The main contribution here is an interesting result showing
64
that separating the complements and counter-pricing them earn the monopolist
higher profit than bundling and coinciding the complements.
4.1
T h e M o d el
To be consistent with the previous chapters, I use same model setup on

the demand side, th at is, a two dimensional preference space in (0, t) for each
consumer, which is his private information. 0 {H : L}, and t has either unit
constant distribution density function over the infinite time line to capture the
idea of an everyday good, or has a mass unit probability function for a holiday
good. Again, the H type consumer is more impatient, i.e., cH > cL.
There are two products, A and B produced by the monopoly firm on
the market, and these two products are perfect complementary goods: they
must be consumed together. Single consumption of either A or B does not earn
the consumer positive utility. Various examples for perfect complements are:
digital camera and memory card, pillow and pillow case, computer and platform
software. Further, goods A and B can be purchased in either one or zero unit.
The unit purchase property is once again required in order to pin down the
closed form solutions.
In the revelation game, each consumer reports his type and preferred con
sumption time ($ ',t'), and the firm assigns him a purchase schedule { P A(6',t'),
65
X A(9',t'), P B(9',t'), X B(9'
P z(9',t.') is the price charged for the good
i,
and X z(0,t') is accordingly the purchase time. Thus, a consumer (6,t) who
reports (9', tr) will obtain the utility:
U{9\ t!\e, t) = 2 0 - P A(0', t') - P B(d>,t') - ce x T(9', t')
(4.1)
T(9,t') is the timing cost:
T{9\t ' ) = ma x { \ XA(6,,t') - t l \ X B{6\t') - t \ , \ X A(9',t') - X B{9',t>)\} (4.2)
This timing cost implies the complementary relation between the two
products. Since both products need to be consumed at the same time, the
storing or postponing time is the longest time period from amongst the purchase
times of products A and B, and the preferred consumption tim e . 1
Relying on the assumption of the firms full commitment power to the
price, we apply the Direct Revelation Mechanism to design the best price strat
egy for both products. The incentive compatibility and individual rationality
constraints (2.2)-(2.7) hold with the utility function (4.1). In addition, parame
ter Assumption
and 2 are restricted in this chapter too.
1WOLG, consider that for a (0, t), X A ( 0, t ) < X B ( 0, t ) . l i t < X A ( 6, t ) , the moment (B, t)
gets to consumer the complementary products is X B ( 0, t ) , so the postponing time waste is
thus X B ( 6, t ) t. If t > X B ( 6, t ) , the consumption time is t, and the storing time waste is
thus t X A ( 0, t ) . If X A ( 0, t ) < t < X B ( 0, t ) , the postponed consumption time is X B ( 0, t ) ,
and the time waste in a first-storing-then-postponing is thus X B (6,t.) X A (0, t).
66
4.2
Consistent with early sections, I normalize /(f) = 1, t (0 0 , 0 0 ), for

both types stable demand over time, where
f.
/(f)
is the density function of
Given the infinite time horizon and the even distribution of consumers, a
natural conjecture is th at the optimal mechanism should show a stationary

cyclic pattern. In each of the cycle, both products are on sale once, and the
monopoly firm repeats this sale cycle infinitely. In this section, I derive the most
profitable cyclic mechanism { P A(9', f ' ) , X A(0I, f ' ) , P B(9', f ' ) , X B(6', f ' ) } that a
monopoly firm would design. To tackle this problem, I start by trying to reduce
the dimensions of the strategy.
L em m a 9 For the selling schedule for the H type, X A(H,t) = X B( H , t ) = t,

for all t.
P ro o f. See the appendix.

This lemma underscores the "no distortion on the top" result. The firm
would not delay or pre-sell to H type consumers. The inter-temporal discrimi
nation is to efficiently differentiate H and L consumers and extract more profit
from H, which is made possible by the different patience levels. To maximally
exploit JTs surplus, the firm may not engage in any strategy incurring IPs
timing cost. The only tradeoff in this discriminating strategy is the timing
distortion for L.
67
W hat is the induced purchase time for L type consumers, or does the
firm let L type purchase A and B at the same time or not? To answer this
question, I separately look into strategies inducing same time and distinct time
purchase for L consumers, and show th a t a distinct time purchase in a specific
form gains the optimal profit for the monopolist.
Two special strategies are investigated. One is to coincide the prices of
A and B. The other is to keep the price of one product fixed and vary the
other. Both of these pricing strategies could induce the dominant strategy of
X A(L,t) = X B(L,t) for all t. Moreover, once X A( L , t ) = X B(L, t) is invoked,
the best price mechanism creates equivalent profit as the best mechanism in the
monopoly single product problem .2
First, let us consider the monopolists strategy if coinciding prices, i.e.,
P A(6,t) = P B(6,t), for all t. Based on the assumption of zero marginal cost
in producing both A and B, charging an equal price between A and B is a
reasonable conjecture. The bundling sale of left shoe and right shoe could be
one example.
Rigorously, coincidence in pricing means the congruency in the
2Once X A ( L , t ) = X B { L , t ), we can denote X A ( 0, t ) = X B ( 8, t ) = X ( 0 , t ) and P A ( 6, t ) +

P B ( 8 , t ) = P ( 8 , t ) - The consumers utility function is reduced to:
U(8' , t \0, t) = 28 - P ( 8 \ t ) - ce x |X ( 8 \ t ) - t\
and the firms profit function is reduced to:

1
fl
m a x - / [ P ( H, t) + P ( L , t ) ] d t
I Jo
This is exactly the monopoly single product problem in Chapter 2.
68
trend of pricing over time. So a proportional pricing P A(0,t) = AP B(6,t) is

allowed and can be easily extended as well, for any fixed finite positive A. Here,
I set A = 1, considering the simplest case.
Lem m a 10 If P A(8, t) = P B(8,t) for all t, then X A(L,t) = X B( L , t ) is the

dominant strategy for all (L, t).
P ro o f. Suppose to the contrary, X A(L,t) ^ X B(L,t) for some (L,t).
Then the firm could propose { P A(L, t ) , X B(L, t), P B(L, t ) , X B(L, f)} for him.
U(L,t)
= 2L - P A(L,t) - P B(L,t)
cL m ax{|X B(L, t) - X A( L , t )|, |X B(L,t) - t\, \t - X A(L,t)\}
<
2 L - P B{L,t) - P B(L,t) - c L\ X B{L,t) - t \
So (L,t) prefers { P A{ L , t ) , X B( L , t ) , P B( L , t ) , X B(L,t)} over {P A( L , t )

, X A(L,t) , P B(L,t) , X B(L,t)}. m
Therefore, we can simplify the notation as X A(8, t) = X B(8, t ) = X(8, t)
and P A{9,t) P B(8,t) = P(0,t). The utility function of (9,t) is reduced to
U(8, t) = 2 8 - 2P(0, t) - ce\X(8, t) - t\
which is almost equivalent to the single product utility function (2 . 1 ).
(4.3)
69
The firms unit profit maximization objective function is the same as the
monopoly single product equation (2 .8 ).
P r o p o sitio n 7 I f P A(6,t) = P B(9,t), then the optimal mechanism is to charge
a cyclic price schedule {P(9,t), X( 9 , t ) } in which:

L e t X { L , x ) = x.
Pa,t) = L - J ^ i f e { H - L ) :
X ( L , t) = x + 21 * i, i is any integer that minimizes {\t x 21 * i\};
P(H,i) = P(L,t) + l c H\t - X(L,t)\,

i f t e [ X ( L , t ) - h , X ( L , t ) + h] ;
h = 2
P(H, t) = H,
i f t e [ X ( L , t ) - l , X ( L , t ) - h ] o r t e [X(L, t) + h , X ( L , t) + I}.
and X ( H , t) = t.
Comparing with the best sales mechanism in the monopoly single prod
uct, the optimal mechanism solution has a very similar expression, which is not
surprising considering the similar utility and profit functions. This is because
of the coincidence of the two pricing patterns which reduces a two dimensional
product space to a single product space.
70
The second strategy is to fix product As price over time. Let P A(9, t) =
a, for all (9, t). The motivation for this type of pricing is the observation of how
electronic devices and their supporting software are usually marketed. Web
cameras and their installation software, or iPod and iTunes are examples. The
software are charged at zero prices, or are free downloadable from the internet,
regardless of the price of the hardware.If we can prove the coincidence
of
purchase time for consumers, then this strategy can again be simplified to the
single product decision.
Lem m a 11 If P A{9, t) = a for all t, then X A(L, t) = X B(L, t) is the dominant

strategy for all (L , t ).
P ro o f. Suppose to the contrary, X A( L , t ) / X B(L, t) for some (L , t ) .
Then the firm could propose {a, X B(L, t), P B(L, t), X B(L, f)} for him.
U(L, t) = 2L a P b (L, t)
- c L m&x{\XB(L, t) - X A(L,t)\, |X b (L, t) - t\,\t - X A(L,t)\}
^
2 L - a - P B( L , t ) - c L\ X B( L , t ) - t \
So (L, t) prefers {a, X B(L, t), P B(L, t ) , X B(L, t)} over {a, X A(L, t ), P B(L, t),
X B(L,t)}. u
71
We can thus denote X A(9, t) = X B(9, t ) = X(8, t) and P B(9, t) = P(9, t ).

The utility function of (9, t) is reduced to
U{8, t) = 2 d - a - P(6, t) - ce\X(8, t) - t\
(4.4)
Again, equation (4.4) bears a similarity to the single product utility func
tion (2.1), with the reserve price 28 a instead of 9. Solving the firms unit
profit maximization problem equation ( 2 .8 ), the next proposition shows this
result.
P ro p o s itio n
I f P A(9,t) = a, then the optimal mechanism is to charge a
cyclic price schedule { P( 8, t ) , X( 8 , t ) } in which:

Let X ( L , x ) = x.
P( L, t ) = (2 L - a ) - 2V/5 ^ ( H
- L);
X ( L , t) = x' + 21 * i, i is any integer that minimizes {|t x 21 * i|};

1 = 2 ,\ / (2
- L);
P(H, t) = P{L, t) + cH\t - X{ L, t )|,

i f t e [ X { L , t ) - h , X { L , t ) + h] ;
^ _
2 H a P(L, t) .
CH
P ( H , t ) = 2H - a ,
if t G [X(L, t) I, X( L, t) /i] or t G [X(L, t ) + h, X ( L , t) + l,\.
and X ( H , t ) = t.
72
Not only does this give exactly the same profit as the first strategy in
Proposition 7, but also the length of their sale cycles and P A(6,t) + P B(0,t)
at any time point are the same. Prom Lemma 10 and 11, both strategies leads
to the dominant strategy of X A( L , t ) = X B(L,t) for L type consumers. Once
we have X A(9,t) = X B(9,t), for all 9, then the firms decision is reduced by
one dimension in the product space. The firm chooses the optimal P A(0,t) +
P B(9, t), and the sale cycle I to maximize its profit function (2.8). The individual
change of P A(9, t ) and P B(9, t ) does not affect the firms profit or the choice of
the length of the sale cycle, as long as their sum is at the optimal level, and
both satisfy ICs and IRs. This is the reason why the coincidence of prices and
keeping one product price fixed could result in the same profit level.
The previous two strategies both achieve the monopoly single product
maximal profit level. But can the firm do better, by separating the two products
other than bundling them together ? 3 The answer is yes. To th at purpose, I
restrict attention to the strategies such that X A(L,t) ^ X B( L , t ), for some t.
L em m a 12 If WLOG X A( L , t ) < X B( L , t ) for some t
[XA(L, t), X B(L, t)],
then for any t' G [XA{L, f), X B(L, t)], X A(L,t') ^ X B(L,t').
P ro o f. Suppose to the contrary, there exists some (L,t') such that t'
[Xa (L, t), X b (L, t)], and X A(L,t') = X B(L,t') = x. Then first it is easjr to
3Bundling together means X A ( $ , t ) = X B (6, t), for all 9 and t.
73
prove th at X A(L,x) = X B(L, x) = x.

If x > t,
2L - P a {L, t) - P b ( L, x) - cL(x - X a (L, i))

>
2L - P a {L}t) - P b (L, f) -
cl [X b
(L ,
f) - X a (L, t)]
because
2L - P a {L, x) - P b {L, x )
> 2
L - P a (L, x ) - P B(L, t) - cl [Xb (L, t) - x]
Therefore, { P A(L, t), X A(L, t), P B(L, x ) , X B(L, x)} is preferred to { P A(L, t),
X A(L, t), P B( L , t ), X B{L,t)} for (L ,t).
Vice versa, if.z < t, then { P A( L , x ) , X A(L,x), P B( L , t ) , X B(L, t)} is pre
ferred to { P a (L, t), X a (L, t), P B(L, t), X b (L, t)} for (L,t). Hence this contra
dicts the purchase time induced to (L,t.) as X A(L,t) and X B(L,t).
Notice th at this proof relies on the cyclicity of the mechanism, so that
we can concentrate on (L, t') with t' [X A(L, t ) , X B(L, t)].
Lemma 12 assures that in the optimal cyclic mechanism, either X A(L, t) =
X B(L, t) for all t. or X A(L, t) / X s (L, t) for all t. Hence we focus on the strat
egy where X A( L , t ) ^ X B( L , t ) for all t. Using the same logic as in Chapter 2,
I try to find the optimal cycle that generates the highest unit profit
21 is the length of a sale cycle, and then repeat this strategy infinitely.
where
74
The IR on L has the restriction that:
U(L,t \L, t)
2 L - P A( L , t ) - P B( L , t ) - c L\ X B( L , t ) - X A(L, t)\X&-5)
=> P A(L,t) + P B(L,t) ^ 2L - cL\ X B(L,t) - X A(L,t)\
The IC on H has the restriction that:
U(H, t\H, t)
2H - P a (H, t ) - P b {H, t )
2 H - P a (L, t) - P b (L, t) - ch \ X b (L, t) - X a (L, t)\
U(L,t\H, t)
(4.6)
Lem m a 13 In the optimal mechanism, IR on L and IC on H must bind.
P ro o f. The proof is trivial by contradiction. If IR on L or IC on H is not
binding, then the firm can do better by increasing sale price or non-sale price to
extract more surplus. This is the standard second degree price discrimination
result.
Lem m a 14 If X A(L,t) f-- X B(L, t) for all t, for the selling schedule to the L
type, { P l(L,t), X l(L,t)}, X l(L. t) must be a discrete mapping with respect to t,
for i {A, 13}. To be exact, for any t such that X ' (L. t ) = t, there exists e > 0,
such that, for any t!
[t e, t + e], X l(L, tf) = t.
75
P r o p o sitio n 9 I f X A(L, t ) ^ X B(L, t), for all t, then the optimal cyclic mech
anism is to charge the price schedule { P l( 9 , t ) , X l(d,t)}, i = { A , B } , in which:

Le t X^ Lt X*) = x 1;
P i(L,t) = !% kEgL;
X l(L,t) = x* + 41 *i, i is any integer that minimizes {\t x 41 * i\};
\ XA( L , t ) - X B(L,t)\ = 2l;
1 H-L
CH
I*(H, t ) - P i{L, t ) + cH\t - X \ L , t)\,

t e [X i( L , t ) - 2 l , X i(L,t) + 2l} ;
and X %(H, t) = t.
Figure (4.1) illustrates this mechanism. The L type consumers are left
with zero utility. The sales are scheduled to just guarantee each L types par
ticipation in the purchase. At any time, one product is priced low, and the
other is priced high, so th at the firm could perfectly extract all surplus from
H type consumers as well. No rent is left for H type consumers, which seems
different from standard literature, and this is due to the linear utility function
setup. The sale price is below L type consumers valuation, since they must be
compensated for the distortion in storing and postponing. Non-sale price is on
the inter-IC and IR of H all the time, fully employing H consumers as well as
keeping them truthfully revealing their types.
76
Figure 4.1: Monopoly Complementary Goods Prices
Proposition 9 gives the optimal cyclic mechanism within the strategies

X A( L , t ) 7 ^ X b (L, t). This can be justified through the welfare analysis. Social
welfare is equal to the sum of the firms profit and consumers surplus. Due
to unit purchase, the social welfare does not depend on the selling price, but
does depend on the social waste in postponing and storing consumption. So the
firms profit is equal to the social welfare minus utility of H and L consumers,
which is a function of I only, I being the sale cycle.4 It can be shown th at
I = -JkZcL is the optimal sale cycle satisfying the IC and IR constraints.
4Denote S W as social welfare. All the variables, 7r, U H , U L and T are aggregate on one
sale cycle 21.
77
As we know from the previous analysis, letting X A(L, t) = X B(L, t) gives

exactly the same amount of profit as the single product monopoly. A meaningful
and applied question is whether a monopoly firm could do better by intentionally
separating a single product into multi-parts and counter-priced selling them. In
other words, is it pooling sales X A( L , t ) = X B(L,t), which gives the monopoly
single product level, or is it separating sales, X A( L , t ) / X B{L,t) th at creates
more profit for the monopolist? Proposition 10 gives the answer.
P ro p o sitio n 10 Under Assumption 1 and 2, separating sales with X A(L,t)

X b (L, t) earn the firm higher profit than pooling sales with X A{L, t ) = X B(L, t ) .

Comparing with the strategy restricting X A(L,t) = X B(L,t), allowing
for different sales time for the two products adds another degree of freedom
in discrimination. And counter-pricing of the complements makes each of the
sales completely unattractive to H types, so the firm can maximally extract their
surplus, while patient L types make purchases from the two sales separately.
As indicated by the proof in the appendix, this proposition depends heav
ily on the Assumption 2, cH > 4cL. In the separating sales, the firm fully ex-
SW
7r(0 + U H + U L
7r(Z) + ( 2 H 2 P H (I)) * 2/ + 0
21 * 2 H + 21 * 2 L T{1)
So, maximizing on Zdfi is equal to minimizing on the timing cost, ^ p - A P H (l).
78
tracts H types surplus, at the expense of delaying or pre-selling products to

L consumers through scattered sales, one product at a time. Intuitively, if the
difference in the two types patience is not distinct enough, then engaging in
such a strategy may lead to a prolonged interval between two product sales.
Assuring L types participation results in a too low sale price th at would be
unprofitable for the firm. Therefore, the separating sales require a higher level
of patience distinction than the pooling sales.
This result has a significant bearing on a monopolists marketing strat
egy for complementary products. T hat is, if it is applicable, left shoe and right
shoe should be separated and priced independently as two products. The com
plementarity further provides a device for a dynamic price discrimination. A
considered look at the marketing practice in reality reveals th at instances as
separating pricing for prefect complementaries are not rare at all, such as m at
tress and bed, digital camera and lens, and iPod and its accessories. There
might, admittedly, be other incentives for these strategy, such as the opportu
nity of various combination to match for diverse demand. But we do observe
distinct sales time for the two complements, and this signifies the discrimination
incentive behind it.
This model supports an argument contrary to the traditional multiprod
uct monopoly literature5, which suggests a dominant bundling strategy" over
5Adams and Yellen (1976) and McAfee, McMillan and Whinston (1989) are the represen
tatives of this literature.
79
separate pricing. W hat drives the discrepancy? One reason is the perfect com
plementarity of commodities, which rules out the motivation for the firm to
create demand for one product by bundling sale. The other key ingredient lies
in a dynamic study versus a static one. Separating pricing offers a way to dis
criminate inter-temporally by coordinating the prices of the two complements
over time.
4 .3
In this final section, holiday complementary goods pricing is investigated.

t has a mass distribution, at t =
, the seasonal/holiday event, a proportion
of the total customers are L, and 1 a are H types. Two complements A

and B are produced by the monopoly firm, with zero marginal cost. Examples
are turkey and stuffing during Thanksgiving and Christmas tree and decoration
accessories during Christmas. The utility function of consumer (0,0) is equation
(4.1), replacing t and t' with 0.
L em m a 15 The optimal strategy { P A(9,0), X A{9,0), P B{9,0), X B(9,0)}, 9 =

{H, L} has the following property in the purchase time: X A(0,0) = X B(9,0) =
X ( 0 , 0) for all 9. Specifically, X A(H. 0) = X B(H, 0) = 0, i.e., H types always
purchase on the holiday.
80
P ro o f. X a (H, 0) = X b ( H) 0) = 0 is easy to prove using contradiction.

Suppose X A(H, 0) 7 ^ 0 and/or X B(H, 0) ^ 0, then the firm can increase both
P a ( H, 0) and/or P B(H, 0) while decrease \ X A(H. 0)| and/or \ X B(H, 0)|. For H
type consumers,
{[Pa (H, 0) + ch \ X a (H, 0)|], 0, [PB(0,0) + ch \ X b (H, 0)|], 0)}

>: { P A( H, 0) , x a (h , 0), P B( H , o) , x b (h , o)}
Thus the firm earns more profit from both types while keeping the participation
and incentive constraints intact.
Suppose WLOG |X A(L,0)| < \ X B(L, 0)|, then L type will find that a
new price proposal is preferred.
{ P a (L, 0) , X b (L, 0), P b (L, 0) , X b (L, 0)}
{ P a (L, 0) , X a (L, 0), P b (L, 0) , X b (L, 0)}
IC and IRs remain valid on the new price schedule.
L em m a 16 In the optimal sale strategy, IR fo r L and IC for H must bind.
81
This result is standard in the second degree price discrimination problem.

We have the following two equations from this Lemma:
U(L,0\L,0)
U{H,0\H,0)
2 L - P a ( L , 0 ) - P b ( L , 0 ) - cl \X{L,0)\ = 0
= 2H - P a (H,0) - P b {H,0)
= 2 H - P a (L, 0) - P b (L, 0) - ch \X{L,0)\ = U(L,0\H,0)
P r o p o sitio n 11 The monopoly firm will play either a separating or a pooling
strategy depending on the ratio of the two types of consumers, { P l(0,0), X l{9,0)},
i = { A , B } , 6 = { H, L} .
If a ^ 'fif, a separating result is played: P A{H, 0) + P B(H,0) = 2H\
X \ H , 0) = 0; P a (L, 0) + P B(L, 0) = 2 ^ ^ ; X \ L , 0) = 2 ^ .
I f Oi > ~ r fy a pooling residt is achieved: P l(H,0) = P l( L. 0 ) , and
P a (H, 0) + P B(H, 0) - P a (L, 0) + P B(L, 0) = 2L; X l{H, 0) - X l{L, 0) - 0.
This proposition follows directly from the profit maximization problem:
m ax{(l - a)[PA(H, 0) + P B{H, 0)] + a[PA(L, 0) + P B(L, 0)]}
conditional on Lemma 15 and 16. In a manner similar to the single product

scenario in Section 2.3, the firm employs a separating strategy given a small
population of L, and a pooling strategy when the pool of L is sufficiently large.
82
This proposition predicts a pre-season and/or a post-season sale for hol

iday complementary goods. In particular, both complements are purchased
together at the same time. Since X A(9,0) = X B(9,0), 9 = {H, L}, the product
space is reduced to a single product. Unlike everyday complementary goods,
the firm does not gain by selling complements separately instead of together as
a whole product. The reason is th at since the firm is aware of the timing dis
tribution of consumers, it is already facilitated with the advantage for a perfect
discrimination. Adding another degree of freedom (one more product) does not
further improve its profit extraction.
83
C hapter 5
Conclusion
This dissertation investigates the inter-temporal price discrimination prob
lem with consumers operating in a two dimensional preference space. It incor
porates a two-dimensional preference space for consumers and provides a closedform tractable solution to the monopoly and oligopoly problems. Firms in this
setup hold sales to screen different types of consumers and thereby extract a
higher profit.
Two qualitatively different incentives drive sales events. The first in
centive arises when, over time, successively more consumers become ready to
purchase a product. Firms hold sales to periodically clear the low valuation con
sumers as they accumulate in the market. The second incentive is manifested in
the face of a demand surge, as happens with holiday and other seasonal events.
Here, a price discriminating firm optimally diverts low valuation consumers to
84
off-peak purchase.
The utility function in this model is analogous to a Hotelling model with
timing replacing geographical location. A unit density distribution of consumers
along the timing axis denotes a stable demand, and this captures the first type
of incentive for sales, as is observed for many everyday products. Contrariwise,
a mass distribution of consumers at a point of time denotes a demand spurt,
as is characteristic of seasonal/holiday goods. The dissertation examines sales
strategies for each of these two incentives under two different market struc
tures, monopoly and oligopoly using the Direct Revelation Mechanism, under
the assumption of sellers full commitment to price.
In the monopoly mechanism design problem, sales events are discrete. A
cyclic pricing pattern is predicted: high, decreasing, at its lowest below the low
types reservation price, increasing, and then high again. The firm will sell to
high valuation consumers anytime they arrive at the market, and clears the low
valuation consumers at the lowest price on one occasion within the cycle. It is
the different levels of patience that provides a channel for the inter-temporal
discrimination.
W hat are necessary conditions for cyclic pricing, for everyday goods with
stable demand and supply? First, the distinction among consumers valuation
should not be too large. An inter-temporal discrimination may not be profitable
for a group of customers with huge differences in reserve price; dropping the L
85
type might be dominant. Second, the distinction among consumers patience

levels must be sufficiently large. Consumers with similar patience may not be
separated efficiently inter-temporally since the waiting or postponing cost is too
close. Third, the ratio of H and L consumers in the population is also relevant.
If one type accounts for too much in the total mass, the firm may completely
exclude the other type in offering the service. This is the intuition behind the
"everyday low price" logo of Walmart, something that is especially an attraction
for low type consumers.
Seasonal/holiday goods are different in that the monopoly firm can per
fectly differentiate between high and low valuation consumers. In the separating
equilibrium, during the holiday event, price is set at as high a level as ensures
the high types participation, while the low type only participates in the pre- or
post-season sale event.
Similar results are obtained in the oligopoly symmetric equilibrium analy
sis, with a limited number of firms competing in the market. For everyday goods,
scattered and discrete sales events are employed when the number of firms in
the market is low enough. The price variation within a sale cycle is qualitatively
akin to the monopoly pattern and firms take turns in holding sales slots. The
competition leads to a lower sale price as well as a lower suppliers surplus com
paring with the monopoly market. In the most profitable collusive equilibrium,
firms alternate in holding sales as well. These results are corroborated in the
86
empirical exercise performed on scanner price data for bathroom tissue.

For a seasonal/holiday good, the price is kept at the high types reserva
tion price during the holiday period. Due to price competition among the firms,
low type consumers can indeed obtain the good at zero price, but the timing of
this sale is distant enough from the holiday season to prevent the participation
of high type consumers.
Perfect complementary goods provide another degree of freedom in dis
crimination. Breaking everyday complements apart and selling them individu
ally yield the monopoly firm higher profit, as it counter-prices the two parts.
However, this strategy does not prove optimal for the monopolist if the com
plements are holiday/seasonal goods, when the firm can perfectly discriminate
consumers even with a bundled single product.
Several important avenues for future research follow from the analysis in
this dissertation. The first is to extend particular aspects of the model analyzed
here. A general utility function, and an unspecified distribution of consumption
timing preferences are obvious candidates. Second, the oligopoly result in the
timing of sales of everyday goods, as presented, follows from restricting the num
ber of competitors. When the market is more competitive, this pooling strategy
to clear low valuation consumers is not supported. A separate investigation of
the pattern of the timing of sales in such a situation is warranted. Third, incor
porating heterogeneous firms within an oligopoly market setting would further
87
enrich the model presented. Finally, the full commitment is a crucial assump
tion in this dissertation. From Folk Theorem, any outcome could be feasible
in a dynamic game, if the outcome satisfies minimax condition. Constructing
punishment strategies may be promising approach to prove the credibility of
sellers full commitment to prices.
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93
A ppendix A
A ppendix
A .l
P ro o fs o f th e L em m as an d P r o p o sitio n s
P r o o f o f L em m a 1:
P ro o f. The proof is composed of the following two steps.
Step 1 : There must exist t such that X ( L , t) = t.

Suppose X ( L , t) ^ t for all t. We can sort U(L, t\L, t ) and call the largest
U (L , t\L, t) consumer (L, tmax). The firm can let X (L, fmax) = fmax and increase
P(L, fmax) until the new sale schedule generates the same level of utility. It is
easy to confirm th at if IRs and ICs are satisfying ex ante, then all IRs and ICs
still hold afterwards. This contradicts the optimization of monopoly firms.
Step2: there does not exist any interval [fy f2], ( fy is not too far away
from fy.) such that for any t [fy, t2\, X( L. t) = t.
94
WLOG, suppose P( L, t i ) < P ( L , t 2), among this continuous sale strat

egy, it is easy to confirm that the best price schedule should be on the IC of (L,t).
P ( L , t ) = P( L, t i ) + cL(t t i ) , t
[t\,t2\. If P( L, t ) > P(L,ti)-\-cL(t ti) then
(L,t) will mimic (L,ti). On the other hand, if P( L, t ) < P( L, t i ) + cL(t t{),
then firm can increase P(L, t ) and extract mor profit while does not affect all
consumers locate outside [<i, *2 ]Let us call the continuous sale { P ( L , t ) , t \ , t
(G, t2\ strategy A.
The idea is to show the existence of a discrete sale strategy B th at dom

inates this continuous sale A.
I introduce strategy B, which is {P(L, t), X( L, t)} such th at X( L , G) = t t
X ( L , t 2) = t2 and X ( L , t )
fo r
The sale prices P( L, t i )
and P(L, t2) are exactly the same as strategy A.

Comparing the two strategies, we should restrict our attention on the
utility and profit on the consumers distributed on [ti,t2\. Next, I am deriving
the profit from both strategies respectively.
Strategy A: Profit from (H,t) and (L. t) on t G [ti,t2] are the same.
< = < = P P(L, t )dt
Strategy B: We need first find out a { P ( H , t ) , X ( H , t ) } , t
[G, Gh such
that all IC and IRs are satisfied.

P ( H , t ) = P( L, t i ) + cH(t ti),
fo r
and P(H, t) P(L, t2) + cH (t2 t), for t
[t*,t2]
t* and P(H, t *) can be solved from the following equations:
H P(H, t)
H P(H, t)
= H - P ( L , t 2) - c H(t2 - t )
p(H,n
p(L,h)P cH+ cL^ - ^
,* _
^1
H -P(L,U ) - ( ^ { t - h )
+ t2
2
cL(t2 ti)
2 c"
Profit from (H , t):
IT
Jti
P(Ii,t)dt+ ^
Jt*
P( H, t )dt
This shows firm can extract more rent from H type.

Profit from (L , t ):
7 f
= P(L, ti)(t.2 t\)
Firm at the same time loses some rent from L type.

At last, I will derive
A H + AL = (tt - irjj) + (tt - tt) > 0
96
A H = vrf - 7r
=
P(L, ti) + cH(t - ti)dt +
P(L, t2) + cH(t2 - t)dt
- fl* P(L, h ) + cL(t - ti)dt

m2
i2
A L = tt ixf = P ( L ,t 1 )(i 2 - ii) - f l l P( L, t i ) + c L( t - t ^ d t

= (t2 - t 1)*(=)
A H + A L = (t2 According to Assumption 2 , cH > 4cL, (t 2 ti) 2 ( -~c4 ch~2c) > 0, when
t2 ^ t \ . Therefore, we have proved A H + A L > 0.
Strategy A is dominated by strategy B, so we conclude a continuous sale
schedule is never optimal for the monopoly firm.
P ro o f. I use two steps for the proof of this lemma.
Stepl: For any (H,t) consumers th at the firm sells to, X ( H , t ) = t.

The proof to this step is trivial. If {P{H, t), X ( H , t)}is for (H,t), and
X( H , t) 7 ^ t, then firm can always propose a new schedule {P(H, t)+cH\X(H, t)
and this does not affect any L types IC and IR. {H,t) weakly prefers
{P(H, t) + cIi\X(H, t) t\,t} over {P(H, t ) , X ( H , t)}, and the firm earns higher
profit.
Step 2 : There does not exist any gap [C, t2], such that the firm refuses to
sell to.
97
Suppose th at the firm pursues the "gap" strategy for [t1 , <2 ]- WLOG,
let P( H, t i ) > P(H, t2). The no mimicking condition restricts th at P(H, ti) ^
P ( H , t 2) + cH(t2 - t 1).
In the interval
there might be no sale happens, or one sale, or
multiple sales. Since multiple sales is a repetition of one sale case, I will consider
only two categories: no sale in between and one sale in between. The idea is to
show this "gap" strategy is a dominated strategy.
a ). no sale in [f1 , t2]
For any t
[h, t2], The IC for H type means P(H, t ) ^ P(H, t\) + cH{t
ti) and P(H. t ) ^ P{H, t2) + cH(t2 t). Binding both conditions, we can solve
for the intersection: t* t-LY 2-
CH ( t
an(j P(H, t*) =
_)_
~ t l )
Firm can propose the following strategy (P ( H , t ) , t ) for any t
[ti. t2]'.
P{H, t ) = mx n { H, P{ H, t l ) + cH{ t - t l ) } , t E [t^t*]-,

P( H, t ) = m m { H , P { H , t 2) + cH{t2 - t ) } , t [t*,t2].
This strategy optimally extracts H types surplus and dominates the
gap strategy, while H types IR and ICs are satisfied.
b). There exists one sale at (P(L, x), x), x
For any t
[ti, t2\.
t2], The IC for H type means:
P ( H , t ) ^ P ( H , t 1) + ca ( t - t 1)
(A.l)
98
(A.2 )
P( H, t ) ^ P(L, x) + cH{x t)
(A-3)
P( H, t ) ^ P ( L , x ) + c H( t - x )
(A.4)
Binding restriction (A.l) and (A.3), the solution is: {P(H, tj), t[}. Bind
ing restriction (A.2 ) and (A.4), the solution is {P(H, t\), t^}.
Firm can propose the following strategy { P( H, t ) , t } for any t
[ti,t2]:
P( H, t ) = min{ H , P ( H , h ) + cH(t - t,)} , t [ ] ;

P(H, t) = min{H,
P (L ,
x) + cH(x t)}, t
P(H, t ) = min{H, P ( L , x) + cH(t x)}, t
G [tj,
P( H, t ) = m in jP , P ( H , t 2) + cH(t2 - i)}, t
x}.
[x, t%\;
G
{t*2 , t 2).
This strategy optimally extracts H types surplus and dominates the

"gap" strategy, while H types IR and ICs are satisfied.
P r o o f o f P r o p o sitio n 2:
P ro o f.
From Proposition 1, we know the sale pattern is an infinite
repetition of an optimal sale schedule.
Therefore, WLOG, I assume a sale
happens on time 0. Abbreviate P( L, t ) = P(L, 0) as P L. Due to the symmetric

distribution of t, we can restriction our attention on half of the sale cycle, i.e.,
t > 0. From ICs and IRs condition for both types,
IR must bind for the critical L consumer, who have zero utility attending
99
sales. I = L [ L.
C
When inter-IC for H binds, we find the critical H consumer location,

h= ^
Cn
For t e [0, h], P(H, t) = P L + cHt. For t [h, I], P(H, t) = H.

We can set up firms unit profit maximization problem.
Case 1: If I > h,
m ax 7r(P i ) =
max j [ P Ll + (I - h) H + [ (PL + cHt)dt]
Jo
c,L (H - P Lf
max P L + H
2cH L - P L
set
= 0, then, P L = L - y f ^ x ( H - L).
From the restriction I > h, P L < c"cf,\^LH Note that under the assump
tion 2, P L <
is guaranteed.
Case 2: If I < h,
m ax 7r(P ) =
m a x j-[P
i p l 1+
i + J/ \ (P
p l + c t)dt]
max 2 P + (
2
dpL
2 -
L P L,
cL
< 0, The optimal price should be P L = 0, and clearly
this is dominated by charging P = H for all t. Hence, this case is ruled out.
100
P ro o f. There are two main steps of the proof. First, I compare two
different strategies, an interval sale and a point sale, and show the domination
depends on the number of firms in the market, N.
Then, I derive this critical
N.
Strategy A: firm holds an interval sale at { P( L, t i ) , t i , P ( L , t 2) , t 2}, i.e.,
X ( L , t ) = t, for t
(ti , t2).
WLOG, suppose P(L, fx) < P(L, t2). Binding the IR and IC restrictions
for both H and L consumers, we have the price rules satisfying participation
and no-mimicking conditions.
P( H, t ) = P{L, t i ) + cH * (tx t), for t
P(L, t ) = P(L, ti) + cL * (tx t), for t
E
E
(hi,ti)
(h, t x)
P( H, t ) = P( L, t ) = P ( L , t 1) + cL * ( t - t 1), for f G (fi,f2)

P(H, t) = P(L, t2) +
cH
* ( t - t 2), for t
P ( L , f) = P(L, t2) + c L * ( t - t2), for t

h i = t l - ^ ^ - h 2 = t2 + ^ M
E
E
(t2, h2)
(t2, l2)
li and l2 are decided by other firms competition. In a symmetric equi

librium, ti li l2 ti, and I denote I = fx lx = l2 t\ ^
^-
The profit from the sales between (hi, h2) is:
= si; p ( l , t,) d t + Jl; p ( l , t2)dt + j ; ; p ( l , t o + c p . ( i - u )dt
101
+ 1vL/h! P ( L , h ) + H * ( h ~ t)dt +
/ t^ 2
P(L,t%) + cH * (t t 2)dt
+ f t I P(L, t\) + cL * (t ti)dt]

Strategy B: the firm holds a single point sale at {P(L,
The profit
from the sales between (hi, h2) is:

* B = f i P ( L , t 1)dt + f p ( H , t ) d t
= f * P(L, h) d t + [t i l P(L, O + c * (h - t)dt
+ Jtl P(L, ti) + cH * (t. ti)dt + Jh 2 Hdt]
where h* = h + H~Pj iLM)
Compare the profit levels between strategy A and B,
Air = irB irA = AirL + AirH
= (til P(L, ti)dt - t i l P ( L , h) d t - Jll P(L, h) dt
~ t i l P (L *i) + L * (* ~ f ^ dt) + j?Utl P (L ti) + cH * ( t - ti)dt + Jl,2 Hdt
~ Jt2 P (L >
+ cff * (t - t2)dt -
/ t' 2
P(L, h ) + cL * ( t - ti)dt]
\ ( h ~ h ) 2 cLl(t2 t-i) + Npi" [(H ~ P ( L , ti))(t2 ty)
~ fi)2]
Note, Att = 0, when t2 = ty.

S if f e lc .- f a ) =
When
'
l;. - ~
-cH
(H - P(L,ti)).
, Air -r 0. This means if the number of firms
in the market is small enough, pooling L type consumers is a better strategy.

On the other hand; if the number of firms is large, firms care less about loyal H
consumers and more about L types, and a separating sales strategy would be
applied.
102
In finding the critical N, two restrictions are applied. One is A 7T = 0,

which means firms are neutral between a discrete sale and a continuous sale.
The other is the benchmark profit restriction, which is any firm th at engages in
a sale activity gains exactly the same amount of profit as if it does not. This is
the consequence from the competition. The following four steps complete the
proof.
1). For a pooling result for L,
: A rc (cH - c L) ( H - P ( L , t l ))
= N,
cHcLl
CH CL l
2).
7r
L ,
7T +7T
op/r
= 2 P(L,ti)l-\
benchmark
, H 2 ~ P ( L , t i )2
-------
H{H-P(L,h))
N c11
2cHP ( L , h ) l
103
3). Find the intersection of the above two equation about N.
cL H - P ( L , t i )
N2 = N 1 x
cH - c L 2 P ( L , t 1)
Mf
N 2 = Ni = N => P ( L , tj) = 2cH _ cL = P e (0, L)
If P( L, t i ) > P. then N 2 < N 1. This gives the area of pooling for L.

4). comparative statics
Step 3 shows the critical price, P. From this P, we can derive the upper
bound of N th at guarantees the pooling for L.
Note I 6. [0, ^ ir ] , and
< 0, ^
< 0. When I increases, both Aq and
N 2 curves move up, the intersection of the two curves move up vertically, i.e.,
P remains unchanged while N goes up. Therefore,
= 0,
< 0. Thus,
the smallest N is achieved when I = C

N = ^cHp^L-P) where P = 2 cHC
- cL Whenever N < N, a pooling strategy
for sales is preferred.
P ro o f.
In the symmetric equilibrium, each firm must earn the same
level of profit, and there should not be any unilateral deviation in terms of price
setting and sale time choosing. For simplicity, I denote sale price P^(L, t) = P
in this proof.
104
7T 7i^enc^imar^
Given I ^ ^ S r \
7r =
H
i f^ r r
/ P d t -\ -f /
Jo
N Jo
benchm ark
is the profit of the firm from [0 , I] who is on sale at t 0 .

/ =
(H-P)2
2N cHP
Given I <
7T =
7r
H - P,
* Hdt 1
nc f
JV
71
7r
P + cH *tdt + (I
H-P.
I Pdt+^-\ I ~ P
P ++ cCM" ** ttdtI
ark = JN .u.
d t }==^benchm
^
is the profit of the firm from [0 , ^pr~\ who is on sale at t, =

7_
{H-Pf
2N cHP
cH P
.
Overall, I = ii2 N c H P , and
-jfe = - E
r/ p i_ < 0.
a I1 U d P
2N cHP 2
This downward sloping curve shows the benchmark profit restriction. At
the benchmark level, a high sale price is associated with a shorter sale interval.
So, the higher sale price, the more frequent the sales are, and vice versa.
2). No unilateral deviation
For any price deviation P ' = P + A P , WLOG, A P > 0; there are two
effects:
a. profit effect: the firm extracts more profit from both H and L types
105
consumers.
business stolen effect: the firm is losing some of L type consumer,
b.
since the L type who located at the margin between two adjacent sales would
prefer to participate the neighbor sale.
The effect of A P on A I is determined by:
L - (P + A P ) - cL(l + Al) = L - P - cL(l - A I) ^ A 1 =
AP
zc
< 0, this is the business stolen effect: for any price increase A P , the firm
lose 2AI L type consumers.
Let h = ~rr~ be the location of marginal H type who pay P(H, t) = H.
A h ~rr- I denote Aw as the profit difference of no deviation minus a
deviation of A P from original price P.
Given
Aw =
AirL + AirH = [ ( P + AP) ( l + A l ) - P l \ + - ^ [ A P h + ^ A P A h ]

, 1
~ (2 ? +
Aw
A p Ap~
,H -P
P
A
+ ( l V ^ ~ ~ 2? + )
II - P
N ch
P
2cL
, _ n_
P
2cL
H -P
N cH
106
Given I <
A tt
A ttl + A ith = [(P + AP) ( l + A l ) - P l \ + ^ [ A P h - ^ A P A h ]

2cL
A tt
2N c H
_ H -P
Ap Ap~
P
2cL
n ch
Overall, I = & -
P
2c1
and =
H -P
N cH
> 0
This upward sloping line is from the restriction of no unilateral deviation.

If sale price is high, firm has less incentive to increase price, since the room for a
further profit extraction from H is small. If sale interval is long, firm has more
incentive to increase price, since the firm can gain more profit from the L type.
This is the reason why I and P are positively correlated to keep balance of the
non-deviation.
3) Combine the two equations in step
and 2
(H-P)2
2 N cHP
2N c H P *
This is the unique solution for {P*,l*} in the symmetric equilibrium.
P ro o f. WLOG, suppose X A( H, t ) < X B( H, t ) for some t. Denote this
( H, t y s purchase schedule is (PA. X A. P B, X B). Let X A/ X A + 5, X Bl =
107
X B 5, P Al = P A + cH5 and P Bl = P B + cH5] for some small <5 > 0. Next I

am going to show by making {PA\ X A/, P Bl, X Br) available, the firm is strictly
better off.
Step 1: For
(PA' , X A>, P B>, X Br) >z {PA, X A, P B, X B), if t
[Xa , X b],
(P A X A', P B, X B) (P A,
P B, X B), if t
(X B ,
oo),
(p a ,x A,P BI, x B') y ( p a ,x A, p b , x B), if t e ( - 0 0 , x A).

The proof is straightforward by comparing the utility associated with the
purchase schedules.
If t
[XA, X %
2H - P A' - P B' - cH{ X B'
X A')=
2H - P A - P B - 2ch 5 - cH( X B - X A - 25)
= 2H - P A - P B - cH( X B - X A)
If t
2# -
G ( X s , oo),
- P s - ctf(t - X Al) = 2H P A cH5 - P B - cH(t - X A - 6)

= 2H - P A - P B - c H( t - X A)
108
If t ( - 0 0 , X A),
2H - P A - P B' - c H{ X B' - t )
= 2H - P A - P B - c H6 - c H( X B - 5 - t )
= 2H - P A - P B - cH( X B - t )
Step 2: For all (H , t '), t' ^ t. ( PAl, X Ar) and ( PB/, X Bl) are dominated.
( PA' , X A>) X (P A:X A), and (P B,, X B') (P B, X B) for all ( H, t r).
2H - PA> - P B - cH m ax{(X s - X A'), (X B
X A')}
2H - P A - c H5 - P B - c H m a x { ( X B - X A'), (X B
X*)}
sC 2H - P A - P B - cH msix{(XB - X A), (X B - t), (t - X A)}
By the transitivity of preference, if (P A, X A) is not chosen by (H , t '),

then ( P A\ X Ar) will not be chosen by (H, t') as well.
Same proof for ( P3', X s ') is dominated strategy for all (H , t ').
Step 3: For all (L , t ), (PA'X Ar) and ( PB,, X Bl) are strictly dominated.
(.P A,, X A>) -< {PA, X A), and (P B,, X B') ^ (P B, X B) for all (L,t).
2L - P A' - P B - cL m ax{(X B - X A>), (X B

=
2H - P A - cH5 - P B - cL m a x { ( X B - X A'), (X B -
<
2H - P A - P B - cL m ax{(X B - X A), ( X B
X A')}
t), (t - X '4')}
X A)}
109
Same proof for (P Bl, X 3') is dominated strategy for all (L,t).
Thus, by introducing (P A' . X A>, P B', X Br), the firm only deviate (H. i) s
choice and does not affect all the ICs and IRs of (H , t') and (L , t). Since P A' >
P A, P 3' > P u , the firm is strictly better off.
Step 4: X a {H, t) = X B( H, t) = t.
WLOG, Suppose X A(H, t) = X B(H, t) = x < t, then there exist ( PA', x', P B>, x'),
x' = x + 5, , P Al P A + cH5 and P Bl P B + cH5\ for some small 5 > 0. Fol
lowing the same logic in step 1 to step 3, we can show that the firm earns higher
profit by proposing (P A' . x', P 3', x') to (H, t). m
P ro o f.
1
max -
subject to IC and IR equations (2.2)-(2.7).
=4> m ax 2 [PL 4 -
where I
\ and h =
=> m ax2[PL + H
cL(H - P L ) 2
2cH{L - P L)
110
,L
L~ \h
2\ l (2 cH + c ^ {H ~ L ^
1 =
P ro o f.
I f1
m a x - { / [P(P,) + P(L,t)]dt + 2a}
^ Jo
subject to IC and IR equations (2.2)-(2.7).
rr,L t - h ^ r r
^
2 P - U- P L
(2H - Cl - P L)2,
=> max[P H
- a) + 2PL
b -------- ] + 2a
where I
and h = 2H % pL .
= m a x fP 1 + 2H - a - P P L - ^ - J L >_ + 2o]
P1
L a 2
I = 2,
2 cH
(2 efl + cL)c
+ cL
(H-L)
(H-L)
I ll
P ro o f. Suppose to the contrary, there exists an interval sale for product
A, i.e., X A (L, t) = t, for t e (ti, t2).

WLOG, suppose P A(L, t 2) ^ P A(L, t2), among this continuous sale strat
egy, then, I will show that this continuous sale is dominated by a point sale at
{ P A( L , t 2) , t 2} only.
The sale price does not affect the unit profit from H type consumers,
since the firm will maximize on P A(H,t) + P B(H,t). When product A is on
sale, product B will be priced high to keep the sum on an optimal level.
Due to the participation constraint, the unit profit from L type is in
creasing in the sale price, P A(L, t).
Therefore, a point sale at { P A(L, A), G} only will dominates the interval
sale.
P roof.
max
subject to the binding IR and IC equations (4.5) and (4.6). And based
112
011
lemma 14. we can rewrite the maximization problem:
max[2Ph + 2P L\
max 2 [PL + cHl + P L]
= m ax 2 [2 L + (cH 2 cL)l\
Since cH > 2cL, the profit is maximized if we max l conditional on all IC and
IRs. I =
and wifi be maximized when P H = H.
ch
L -
cl
cH cL
H -L
cH - cL
P ro o f. Let strategy 1 be the pooling sales in which X A(L, t) = X B(L, t),
the optimized sale price be P 1 = P A(L, t) = P B(L, t) L y j j cff'+c1

and the maximized unit profit be j
= 2 [P1+ H
~ L),
ry] as from Proposition
7.
And denote strategy
the separating sales, X A(L,t)
optimized sale price P 2 = P A(L, t ) = P B(L, t) =
7^
X B( L , t ), the
, and maximized unit
113
profit
= 2[P 2 + if] as from Proposition 9.
- 1 -
= 9(pi -
21
^CH CL
P 2t -
c L( f f ~ p l ) 2 1
2cH{L P 1)
\ / 2CH + CL^ H
L^
cL
/
c1
since - n - r < \ - rj- r when 4cL < cH
cH - cL
V 2 cH + c
= P 1 < p 2 => E 1 < J 2
I
21
Hence separating sales, X A(L, t) ^ X B(L, t) is a more profitable strategy
A .2
C om p arison w ith C G S (1984) an d S o b el
(1 9 9 1 ) for E v ery d a y G o o d s M o n o p o ly
The main difference of assumptions between Sobels model and mine lies
in the patience levels of the consumers and the monopoly firms. CGS and
Sobel use discount factor to capture the postponing cost. The storing cost is
treated as infinitely large, since consumers cannot purchase before they arrive
at the market in their model. Further, both types of consumers and the firm
share a common discount factor, so they are equally patient in waiting for a
consumption or a revenue. Denote 5H, 5L and 6f as i f type, L type and the
114
firms discount factors respectively, then 5H = 5L = SF.

The model in this dissertation allows two directions of timing cost, for
pre-consumption as well as post-consumption. And this timing cost is char
acterized by a direct product of patience indicator and the time of purchase
distortion. To be simple, I focus on symmetric timing cost structure in which
storing and postponing are assumed to be equally costly for the consumers. In
addition, the firm is non-discounting, and H type consumers are less patient
than L type consumers. Denote cH, cL and cF as H type, L type and the firms
unit timing costs respectively, then cH > cL > cF = 0 .
First, I show that with cH cL = cF in my model, cyclic mechanism is
not the optimal strategy for the monopolist. And this proves th at the hetero
geneous patience is the necessary condition leads to the cyclic mechanism, the
fundamental different result from early literature.
L em m a 17 I f cH = cL = cF, then the cyclic mechanism is dominated by setting

P(0, t) L for all t.
P ro o f.
L ~ \ j 2cH+cl
Recall the optimal cyclic mechanism in Proposition 2, P L =

L), and the firms unit profit 7r = max P L + H fpr
Let cH - cL, then P L = L - y J \(H - L ) and tt = 2L - y/Z{H - L ).

By charging P(6, t ) L. the firms unit profit 7r = 2L. Therefore, a flat
rate P(9, t) L dominates cyclic pricing.
115
Introducing the inventory cost for the firm cF, the firms unit profit func
tion with cyclic sales becomes
m ax 7r =
max
fl
- / \P(H,t) + P(.L,t) cFt}dt
P(H,t),P(L,t) I J o
It is easy to see th at this profit is decreasing in cF. Therefore, we can

conclude if cH cL = c1' , a cyclic mechanism is dominated by charging a
constant rate at L. m
Next, I show that SH > 8F = 0 in CGS and Sobels model, a cyclic
mechanism may obtain higher profit for the monopolist than a flat price over
time. This signifies that it is not the simplifying assumptions of symmetric
timing structure or the linear timing cost that result in the cyclic sales pattern.
The true source of the cyclicity is the heterogeneous patience among the three
parties: H and L consumers and the monopoly firm.
L em m a 18 Allowing 5H > dF = 0 in CGS and Sobels model, there exists a
cyclic mechanism that dominates static monopoly price.

P ro o f. According to Sobels model, the utility function for consumer
(6>, t) is
U(0, t) = [9 - P{B, t)} * e - f W W - t )
and X (8, t ) > t.

Consider a cyclic mechanism, with cycle length I, with the first sales
116
happening at time I. Thus, the binding IR for (L, t) restricts P(L, t) L, and
the binding IC for (H , t) restricts P (Ii, t) = H (H L)e~6" {l~L]. for t (0,1).
The monopoly firms profit from this cyclic mechanism is
ttc =
max - { Z * L * e'~sFl + / [H - (H - L)e~sHW ] * e sFtdt}

1
Jo
The monopoly firms unit profit from charging P{9, t ) = L is ttl =

j(/q 2 L * e
Jit), and the unit profit from charging P(6,t) = H is tth
l ( / o H * e - * '* * ) . '
When 5f = 0,
ttc -
max{L + H - - / [(H L)e~sH^ d t }

1
tcl
Jo
2L
Sobels result could be verified here, imposing dH SL S1, = 6.

If H > 2L, then
n H - ttc
j { - l L e ~ sl + f [ ( H - L ) e - s V- V - 5t}dt }
( H - 2 L ) e ~ si > 0
Jo
And if i f < 2 L, then

1
nL - n c
f*
- { - l L e ~ sl + /
[( 2 L - H ) e ~ Sid t +
Jo
{H Jo
^ ^ - [ l - ( l + S l ) e - sl} > 0
Therefore, cyclic sale is dominated by either consistently charging P ( 6 , t ) = H , or P ( 6 , t ) =

L for all t.
117
L){ 1 - - L ( l - er&Hl)] > 0

o t
for any positive SHl. m

Although in CGS and Sobel, H type and L type consumers are assumed
with same discount factor, L types are extremely patient in terms of waiting for
assumption. This is because of the exponential discounting process: whenever
the price is below or equal to the L type's valuation, he will make a purchase
no m atter how long he has been on the market. Hence, only 5H and 5F appear
in the firms profit maximization problem.
To sum up, the heterogeneous timing cost among the H type consumers,
L type consumers and the firm result in the cyclicity in the optimal mechanism.
And the likelihood of a dominating cyclic mechanism increases in the H types
timing cost, and decreases in the L type and the firms timing cost.
A .3
A d o p tin g a S p ok es M o d e l for E v ery d a y
G o o d s O lig o p o ly
The model setup is very similar to the one in Chen and Riordan (2006).
Consumers are evenly distributed on the terminal of N spokes, which stand for
N potential brands for a homogeneous product. There are N brands in the
markets, locating on the N terminals out of N of them. Therefore, each firm
118
naturally attracts 1 / N loyal customers, and loyal customers have high valuation
towards the product. The total number of L types in the market is 1 N / N , the
unmatched consumers. W ith this speculation, when a new variety is introduced,
it is only another 1 / N of L type consumers th at transfer into loyal consumers.
Therefore, the loyal consumers preference switch problem is solved. This model
also provides a natural scheme to generate the loyal H valuation consumer.
Same question will be asked here: with Spoke Model, do we have pooling
strategy for L types? The answer is still ambiguous. The counterpart to Lemma
7 is:
L e m m a 7a For selling schedule for loyal consumers, {P(H. t), X ( H , t)},
X ( H , t ) = t. For selling schedule for L type customers, {P(L, t), X ( L , t)}, how
ever, there exists a critical number J of
firms
J
in the market, N 2=
N ^p Z.p^ ct. ,
cH P ( L ~ P y
where P = ^ i 7~ r , ' such that if the number
of firms N < N , X ( L , t ) = t for all
t. a separating selling is provided to L. On the contrary, if N > N , sales are

scaitered, i.e., for any t such that X ( L , t ) = t, there does not exist e > 0, such
that for any t' E [t e, t + e\, t! ^ t, X ( L , t') = t'.
P ro o f. Same as in the proof for Lemma 7, two restrictions are applied.
First, firms are neutral between a discrete and a continuous sale, i.e., A-7t = 0.
Second, each firm earns the benchmark profit due to the competition.
119
1). For a pooling result for L,
A?r =
(i - = ) [ ~ { t 2 - P ) 2 - cLi{t2 H
^
^
~NCH ^
- t-i) - (* 2 - *l)2]
OAtt
,
AC
cH - CL
|(tl=i2) = - ( 1 - = ) c Ll + ^ = r (H - P ( L , h ) ) > 0
3 (t 2 - t i ) Ul 2j
v
AT
Nc H
cHcLl
2). Benchmark profit restriction,
AT
=
7T
know* _
A/c*
2H(H -_P{L,h))
N cH
2cHP(L, ti)l
Combining step 1) and 2), we can solve the critical number of firms in
the market,
S = VP
2cHP ( L - P )
Hc L
2 cH - cL
120
As a contrast to earlier finding, a larger N encourages pooling strategy for

L. This is due to the opposite assumption of loyal consumer generation process
from in the main part of the dissertation. In the original analysis in Section
2.3, when N increases, the number of loyal consumers for each firm shrinks and
L type consumers accounts more. Employing Spokes model, when N increases,
the pool of H type loyal consumers for each firm remains constant, while the L
types shrink. This stimulates the firms to attach more importance to extract
loyal customers instead of competing for L. Hence, the benefit to screening
dominates the need to compete when N is large. This is not surprising, however,
since in the original paper about Spokes Model by Chen and Riordan (2006),
consequences that more firms lead to higher equilibrium prices are found.

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T im in g o f S ales w ith H e te r o g e n e o u s C o n su m er

Submitted in partial fulfillment of the

UMI Number: 3285116

ProQuest Information and Learning Company

This dissertation models retailers pricing strategies in holding sales for

model provides a plausible explanation of the empirical pattern of sales, and a

In tro d u ctio n .........................................................................................

Literature R eview ................................................................................

Static Sales L ite r a tu r e .........................................................

Dynamic Sales Literature

Price Discrimination with Multi-dimensions or Competi

M o n o p o ly M ech a n ism D e sig n

2.1 The M odel.............................................................................................

2.2 Analysis of Everyday G o o d s .............................................................

2.3 Analysis of Holiday G o o d s .................................................................

O lig o p o ly S y m m etric E q u ilib riu m

3.1 Analysis of Everyday G o o d s .............................................................

Data D e sc rip tio n ...................................................................

3.3 Analysis of Holiday G o o d s .................................................................

3.2 Empirical Evidence from Supermarket Scanner D ata

4.1 The M odel................................................................................

4.2 Analysis of Everyday G o o d s .............................................................

4.3 Analysis of Holiday G o o d s ................................................................

A .l Proofs of the Lemmas and P ropositions..........................................

D ata D e sc rip tio n ................................................................................

Purchase Time D is to r tio n ................................................................

Monopoly Everyday Good P r i c e ......................................................

Monopoly Holiday Good P r ic e .........................................................

Oligopoly Everyday Good P r i c e ......................................................

Charmins versus N o rth e rn ...............................................................

Oligopoly Holiday Good P r i c e .........................................................

Monopoly Complementary Goods P r i c e s ......................................

A cknow ledgm ents

my husband, bearing with me at my ups and cheering me at my downs, he is

daughter Melody is added to the list recently. She completes me as a mother

To my parents, my husband and my daughter Melody.

Price dispersion among retailers is a commonly observed phenomenon,

Most works extending in this direction find it

valuation of quality. The model developed in this dissertation works in two di

sales. The Revelation Principle is usually invoked in the theory of implementa

For everyday goods,

The second contribution is more fundamental. The model developed

6See Armstrong (2000) for more discussion.

The theoretical literature of sales originates with the observation of failure

nonlinear pricing with respect to time.

S ta tic Sales L iterature

contrast to Varians approach. Firms charge different prices in the dispersion

this topic are most closely

related to the model in this dissertation.

nation in an oligopoly market. Most of the assumptions on the product and

price in a commitment mechanism design. Third, I find a closed-form pure strat

P rice D iscrim in ation w ith M u lti-d im en sion s or C om

argument on this topic is th at distortion will disappear when the market is

increase, the exit of low-demand consumers is outweighed by the gain from

They transfer the multi-dimensional pref

Katz (1984) explore price discrimination and monopolistic competition by

M onopoly M echanism D esign

A homogeneous product market with zero marginal cost is assumed. Con

The dual characteristics (9,t) are private information to each

consumer and arbitrage can be prevented by the firm.

U (9\ t'\9, t) 9 P(0', t') - c 9 x |X (9', tr) - t\

and the L type consumers are same fo r everyday good model.

A ssu m p tio n 2 Parameter assumptions: H < 2 L and cH > AcL.