Dynamic Pricing over Finite Horizons: Single Resource Case Guillermo Gallego Spring 13 Abstract In this chapter we consider the problem of dynamically pricing one or more products that consume a single resource to maximize the expected revenue over a finite horizon. We assume that there is a sunk investment in capacity that is not-replenishable over the sales horizon. We formulate continuous and discrete optimal control problems for price sensitive, Poisson and compound Poisson, demands. We discuss the advantages and disadvantages of dynamic pricing versus fixed pricing and versus quasi-static pricing policies. We use Approximate Dynamic Programming with affine functions to obtain an upper bound on the value function and to develop heuristics that are asymptotically optimal as the size of the system scales. We then consider pricing with finite price menus and semi-dynamic pricing strategies. 1 Single Product Dynamic Pricing In this Chapter we consider the problem of dynamically pricing one or more products that consume a single resource over a finite horizon with the objective of maximizing the expected revenue that can be obtained from c units of capacity over a given selling horizon. We will measure time backwards so that t is the time-to-go until the end of the horizon. At the start of the selling season the time-to-go is T . We assume that the salvage value at the end of the horizon is zero to reflect the fact that in many applications the product is perishable. If there is a positive salvage value then the objective is to maximize the expected revenue in excess of salvage value, so the zero salvage value can be made without loss of optimality. We will assume that the capacity provider cannot replenish inventory during the sales horizon. This assumption holds for hotels and seasonal merchandise including fashion retailing, and to a large extent to airlines who allocate planes to routes but may, in some cases, swap planes of different capacities to better align capacity with demand. We will assume that customers arrive as a time heterogeneous Poisson or compound Poisson process. Expositionally, it helps to introduce the basic formulation for the Poisson case and later take care of the changes needed to deal with the compound Poisson case. It is also 1 helpful to initially work with a single product and then show how that under mild conditions the same formulation works for multiple products consuming a single resource. The pricing problem for multiple resources will be dealt in a different Chapter. Let dt(p) be the Poisson arrival rate of customers willing to buy at price p ∈ <+ at time t. We assume that customers unwilling to buy at price p leave the system. Let rt(p,z) = (p−z)dt(p). We know from the Static Pricing Chapter that if dt(p) is upper semi-continuous, and ∫∞ 0 d̄t(p)dp < ∞, where d̄t(p) = supq≥p d(q), then there exist a finite price pt(z), increasing in z, such that rt(z) = supp≥0 rt(p,z) = maxp≥0 rt(p,z) = rt(pt( ...