Whether we sell goods or services, we all have to put price tags on them. To find optimal prices, we need to understand how customers respond to prices. One way to do that is using price-response functions. In this article, we will build the function with machine learning and use them to optimize pricing strategies in the following order.
- Pricing Basics : Explain the law of supply and demand, and different price-response functions
- Price-Response Function with Machine Learning : Build price-response functions with neural network models
- Pricing Optimization : Find the best price changes by applying optimizers to price-response functions
We will use an example dataset artificially created by this process that imitates typical e-commerce data.
1. Pricing Basics
We all know supply and demand matter in pricing. More demand than supply leads to higher price, and the other way around. We call it “the law of supply and demand”. The following is an example to describe prices relative to demands. This is a very simple “price-response function”.