Simple Economics of the Price Setting Newsvendor Problem

in Applications to Firms, Sectors, and Industries, Research Day
May 14th, 2012

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Michael Salinger

Markets, Public Policy and Law

Authors: Michael Salinger and Miguel Ampudia

The Lerner relationship linking the profit-maximizing price to marginal cost and the elasticity of demand generalizes to the price-setting newsvendor and the result resolves the puzzle over the different effects of additive and multiplicative uncertainty on the solution. Multiplicative uncertainty increases the optimal price because it increases the marginal cost of a unit sold and does not affect the mark-up factor. Additive uncertainty has no effect on the marginal cost of a unit sold and lowers the mark-up factor because it increases the elasticity of the average quantity sold with respect to price.