A rationale for trade-ins

We explain trade-ins as a device used by a monopolist to price discriminate between new and repeat buyers. We show how the monopolist creates and subsequently exploits market segmentation. A two-period model is considered. In the first period, the seller sets a price which divides the second-period market into old and new customers. In the second period, he uses trade-ins (discounts for old customers) or introductory offers (discounts for new customers) to price discriminate between buyers. We analyze the optimal segmentation of customers; i.e., we determine the optimal price for each consumer group as a function of the durability of the good, its production cost, and the discount factor. The qualitative decision of whether to give a discount to old or new customers also depends on these parameters. We consider a second model in which discounts are only available to repeat buyers, and compare our results to a base model without price discrimination.