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 informativeness of the market outcome 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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Find related papers by JEL classification: C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
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Slade, Margaret E, 1989.
"Price Wars in Price-Setting Supergames,"
Economica,
London School of Economics and Political Science, vol. 56(223), pages 295-310, August.
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