Menu Pricing and Learning

Abstract

We address the question of designing dynamic menus to sell experience goods. A dynamic menu consists of a set of price-quantity pairs in each period. The quality of the product is initially unknown, and more information is generated through experimentation. The amount of information in the market is increasing in the total quantity sold in each period, and the firm can control the information flow to the market by adjusting the level of sales. We derive the optimal menu as a function of consumers' beliefs about product quality, and characterize the changes in prices and quantities resulting from information diffusion. The equilibrium menu prices are the result of a dynamic trade-off between immediate gains from trade, information production, and information rents. The firm initially charges lower prices, in order to increase sales above the static optimum, sacrificing short-term gains in order to invest in information. As the market obtains more information, the firm gradually shifts to a policy designed to extract revenue from high-valuation buyers. This policy may eventually exclude low-valuation buyers from the market, even if the product's underlying quality is in fact high.