Strategic Information Diffusion

Abstract

Frequent drops of prices to zero is a common phenomenon in price trends of many smartphone applications. The only means by which many of these apps spread is the word of mouth of their users. Motivated by these observations, we study the problem of optimal dynamic pricing in a social network where agents can only get informed about the product via word of mouth from a friend who has already bought the product. We show that for a durable product such as many apps, the optimal policy should drop the price to zero infinitely often, giving away the immediate profit in full to expand the informed network in order to exploit it in future. We further show that, beside the word of mouth nature of the information diffusion, this behavior crucially depends on the type of the product being offered. For a nondurable product, although the firm may initially make some free offers to expand its network, after a finite period, it will fix the price at a level that extracts the maximum profit from the already informed population.