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Experimentation in Markets

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  • Dirk Bergemann
  • Juuso Valimaki

Abstract

We present a model of entry and exit with Bayesian learning and price competition. The value of the new product is initially unknown in the market, but purchases of the product yield information on its true value. We assume that the performance of the new product is publicly observable. As agents learn from the experiments of others, informational externalities arise. We determine the Markov Perfect Equilibrium prices and allocations in different market structures. In a single market, the informational externality among the buyers leads to too much learning. If the entry of the new product occurs in many distinct markets, then efficiency is reestablished in the limit as the number of markets grows. We finally analyze entry into different market segments and show that the new firm starts by selling to the informationally inexpensive buyers.

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Bibliographic Info

Paper provided by Northwestern University, Center for Mathematical Studies in Economics and Management Science in its series Discussion Papers with number 1220.

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Date of creation: Apr 1996
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Handle: RePEc:nwu:cmsems:1220

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References

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  1. Abhijit Banerjee & Drew Fudenberg, 2010. "Word of Mouth Learning," Levine's Working Paper Archive 723, David K. Levine.
  2. Dirk Bergemann & Juuso Valimaki, 1997. "Market Diffusion with Two-Sided Learning," RAND Journal of Economics, The RAND Corporation, vol. 28(4), pages 773-795, Winter.
  3. Bergemann, Dirk & Valimaki, Juuso, 1996. "Learning and Strategic Pricing," Econometrica, Econometric Society, vol. 64(5), pages 1125-49, September.
  4. Felli, Leonardo & Harris, Christopher, 1996. "Learning, Wage Dynamics, and Firm-Specific Human Capital," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 838-68, August.
  5. Gale, D. & Chamley, C., 1992. "Information Revelation and Strategic Delay in a Model of Investment," Papers 10, Boston University - Department of Economics.
  6. Dirk Bergemann & Juuso Valimaki, 1996. "Experimentation in Markets," Discussion Papers 1220, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  7. McFadden, Daniel L & Train, Kenneth E, 1996. "Consumers' Evaluation of New Products: Learning from Self and Others," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 683-703, August.
  8. Godfrey Keller & Sven Rady, 1998. "Optimal Experimentation in a Changing Environment," Game Theory and Information 9801001, EconWPA.
  9. Rothschild, Michael, 1974. "A two-armed bandit theory of market pricing," Journal of Economic Theory, Elsevier, vol. 9(2), pages 185-202, October.
  10. Patrick Bolton & Christopher Harris, 1999. "Strategic Experimentation," Econometrica, Econometric Society, vol. 67(2), pages 349-374, March.
  11. Kenneth Hendricks & Dan Kovenock, 1989. "Asymmetric Information, Information Externalities, and Efficiency: The Case of Oil Exploration," RAND Journal of Economics, The RAND Corporation, vol. 20(2), pages 164-182, Summer.
  12. Rob, Rafael, 1991. "Learning and Capacity Expansion under Demand Uncertainty," Review of Economic Studies, Wiley Blackwell, vol. 58(4), pages 655-75, July.
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