Upgrade pricing, market growth, and social welfare

This paper studies the monopolist's dynamic pricing strategy when introducing successive generations of a durable product. We show that when consumers are semi-anonymous or exactly identified and the innovation is minor, the firm always offers an upgrade discount to former customers. However, the discount depends only on the quality of the old product. In contrast, for moderate and major innovations, the discount depends on the qualities and costs of both the old and the new products. The market growth rate affects the firm's pricing strategy only if consumers are anonymous; furthermore, the effect on prices depends on the discount rate and whether the market growth rate is high or low. For minor innovations, social welfare is maximized if consumers are anonymous. An interesting and paradoxical result is that, when innovations are moderate or major and consumers are semi-anonymous or exactly identified, price discrimination can actually lead to higher social welfare.