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Market Experimentation in a Dynamic Differentiated-Goods Duopoly

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  • Godfrey Keller
  • Sven Rady

Abstract

We study the evolution of prices in a symmetric duopoly where firms are uncertain about the degree of product differentiation. Customers sometimes perceive the products as close substitutes, sometimes as highly differentiated. Firms learn about their competitive environment from the quantities sold and a background signal. As the information of the market outcomes increases with the price differential, there is scope for active learning. In a setting with linear demand curves, we derive firms' pricing strategies as payoff-symmetric mixed or correlated Markov perfect equilibria of a stochastic differential game where the common posterior belief is the natural state variable. When information has low value, firms charge the same price as would be set by myopic players, and there is no price dispersion. When firms value information more highly, on the other hand, they actively learn by creating price dispersion. This market experimentation is transient, and most likely to be observed when the firms' environment changes sufficiently often, but not too frequently.

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Bibliographic Info

Paper provided by Suntory and Toyota International Centres for Economics and Related Disciplines, LSE in its series STICERD - Theoretical Economics Paper Series with number 369.

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Date of creation: Jul 1999
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Handle: RePEc:cep:stitep:369

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Web page: http://sticerd.lse.ac.uk/_new/publications/default.asp

Related research

Keywords: Duopoly experimentation; Bayesian learning; stochastic differential game; Markov-perfect equilibrium; mixed strategies; correlated equilibrium.;

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References

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Cited by:
  1. Dirk Bergemann & Juuso Valimaki, 1999. "Entry and Innovation in Vertically Differentiated Markets," Cowles Foundation Discussion Papers 1226, Cowles Foundation for Research in Economics, Yale University.
  2. Heski Bar-Isaac, 2001. "Self-confidence and survival," LSE Research Online Documents on Economics 19329, London School of Economics and Political Science, LSE Library.
  3. Dirk Bergemann & Juuso Valimaki, 2000. "Entry and Vertical Differentiation," Cowles Foundation Discussion Papers 1277, Cowles Foundation for Research in Economics, Yale University.

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