Pricing and Capacity Allocation Strategies of Suppliers in an Electronic Market

We analyze a problem where a market maker on behalf of buyers allocates a given amount of order among N suppliers each with finite capacity. Specifically, we analyze a situation in which suppliers have the option of going to open market and selling their capacity at a market price. However, the supplier will incur search costs. Moreover, the demand for the supplier capacity in the open market is stochastic. Based on these, we derive the capacity-price curve (supply curve for capacity) for each supplier. The capacity-price curve of the suppliers provides a basis for the market maker to allocate the order among the suppliers so as to minimize his cost. We also identify the key parameters that will influence the overall performance of the electronic market place.