On the Welfare Implications of Dynamic Pricing for Brick and Mortar Retail: The Case of Non-Perishable Goods

Abstract

We argue that dynamic pricing motivated by the management of inventory holding and ordering costs leads to increased operational efficiencies which could benefit firms without hurting consumers. To demonstrate this point, we equip the traditional economic order quantity (EOQ) setting with a rich set of demand models and compare social outcomes under two alternatives, dynamic and static pricing. We show that dynamic pricing generates higher retailer profits, a lower average price per unit sold, and higher sales volumes than static pricing. The mechanism behind the result is that with dynamic pricing the retailer ties the price of each unit to its holding costs, which allows him to increase the order quantity compared to static pricing and thus save on fixed ordering costs. Some of these cost savings are passed to consumers. Moreover, we demonstrate that this mechanism is robust to the presence of price-anticipating (strategic) consumer behavior.