Abstract
Potential customers in customer markets are typically dichotomised into actual and prospective customers. If the firm holds its price firm, the actual customers hold their reserves/reservation price firm and repeat their purchases. On the other hand, prospective customers’ reserves may be volatile due to their non-equilibrium market experience. One may regard a prospective buyer with a volatile reserve as imperfectly rational. On the other hand, one may suppose that an actual customer with a firm reserve is fully rational. We examine this hitherto-neglected asymmetry in customer markets to highlight that a firm can use imperfectly rational and prospective customers-characterised by their volatile reserves-as a European option. As the volatility increases, so does the value of the option of selling the products to the prospective customers. We also establish that volatility of reserves and hence imperfection in rationality of buyers, can have positive impact on output and employment in customer markets.
Highlights
Customer markets are typically characterised by information asymmetry Scitovsky[1], Stiglitz[2] customers are fully aware of the price of their patronised firm, but less aware of the prices of other firms
With an increase in volatility of the reserves of the prospective customers, the value of the option to sell the products to the prospective customers increases
We find that the degree of risk aversion of the firm will determine whether the output and employment effects of the volatility of reserves on the customer markets are positive, or otherwise
Summary
Customer markets are typically characterised by information asymmetry Scitovsky[1], Stiglitz[2] customers are fully aware of the price of their patronised firm, but less aware of the prices of other firms. If a firm raises its price-following a positive price shockall of its customers whose reserves/reservation price are less than the new price will instantly disappear. This will cause an upward movement of the concerned firm along the demand function. Stiglitz[2] analysed static search markets with homogenous goods to predict similar discontinuity in firms’ marginal revenue functions)[6,7]. Such information asymmetry naturally causes asymmetry in customer flows. Customers have an incentive to offer loyalty due to switching cost[10], or because of information asymmetry[1,2,11]
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