Faculty of Economics and Business Administration Publications Database

The Ability to Compensate for Suboptimal Capacity Decisions by Optimal Pricing Decisions

Spann, Martin
Volume: 118
Number: 3
Pages: 450 - 463
Month: November
ISSN-Print: 0377-2217
Link External Source: Online Version
Year: 1999
Keywords: Marketing; Pricing; Capacity; Peak-load pricing; Flat maximum principle
Abstract: Certain companies have high capacity cost and rather moderate production cost. These companies usually assume that deciding about their capacity is quite critical. Frequently, however, they are able to adjust the demand for their products to the available capacity by setting appropriate prices, that is higher (lower) than current prices in the presence of under-capacity (over-capacity). We argue that appropriate prices can reduce the adverse effects of non-optimalcapacities. We analyze the sensitivity of profit in such a situation for a company in a monopolistic market, selling a non-storable product and facing fluctuating but interdependent demand across two time periods which allows to profitably differentiate prices. Therefore, we state optimality conditions for prices in situations of variable and given capacities and describe a procedure to determine them. The main suggestion of this analysis is that, within the bounds of the normative models and specific parameters examined, optimal prices can substantially reduce the adverse effects of capacity deviating from its optimum. In this way, profit is rather insensitive to deviations of capacity from its optimum. The implications of this finding are discussed for a number of situations.