Countercyclical Pricing in Customer Markets

I present a dynamic model of price determination in customer markets that are subject to exogenous business cycle fluctuations. The business cycle is described in terms of a Markov process, in which market demand alternates stochastically between fast growth (boom) and slow growth (recession) phases. In the consumers' preferred equilibrium outcome, (1) prices are below the monopoly level, and (2) prices are countercyclical when demand growth rates are positively correlated through time. A firm faces a dynamic trade-off when making its current price selection. While a higher price may raise a firm's profit in the short term, it also may diminish the firm's reputation for low prices, leading to lower profits in the future.