David G. Bakken is chief operating officer of KJT Group, Inc. His blog “The Customer Knowledge Advantage,” may be found at davidgbakken.wordpress.com. He may be reached at DavidB@kjtgroup.com.
In principle, any firm that knows its costs and also knows the demand at each possible price can find the profit maximizing price. Although firms may, in fact, have only a rough idea of true costs, the main challenge in setting price is determining the level of demand at different price points. Firms have few options when it comes to determining the demand curve for an offering. In some cases, they may be able to conduct live test markets or other in-market experiments, or they can use temporary price promotions to estimate a demand curve of sorts. In the real world, auctions can be an effective tool for finding the “market clearing” price, and Internet-enabled auctions have changed pricing for some categories of goods and services. Google’s position auction is arguably the most successful implementation of the auction method for maximizing profitability.
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