4 Agency vs. wholesale pricing We are going to compare two different pricing models that are common in the manufacturer-retailer relationship and are known as agency and wholesale pricing. There is one publisher and one retailer. The inverse demand function for an eBook is given by P = 16—Q, where P is the price consumers pay for an eBook and Q is the quantity they purchase. eBooks are assumed to cost nothing to distribute.
Agency pricing: The publisher sets a price P and the retailer must charge that price P for eBooks. The publisher gets some share 1— s of the profits and the retailer gets share s.
Wholesale pricing: The publisher sells eBooks at a price p to the retailer. Then, based on this price p, the retailer chooses a price P to charge consumers.
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(a) What is the price consumers pay under agency pricing? (Hint: Maximizing share (1-s) of the profits is equivalent to maximizing the entire share of profits. Therefore, this problem is your basic monopoly pricing problem with a linear demand function.) (b) What is the price consumers pay under wholesale pricing? (Hint: The game between the publisher and the retailer can be solved by backward induction. First, determine the optimal decision of the retailer as a function of the publisher’s price. Then solve for the optimal publisher price. In each case, you have to solve a simple monopoly problem with a linear demand function.)
(c) Under which pricing model is consumer price the highest? Why?
