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Market Experimentation in a Dynamic Differentiated-Goods Duopoly

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Author Info

  • Godfrey Keller

    (London School of Economics)

  • Sven Rady

    (Graduate School of Business, Stanford University)

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 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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Bibliographic Info

Paper provided by EconWPA in its series Game Theory and Information with number 9810001.

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Length: 37 pages
Date of creation: 16 Oct 1998
Date of revision: 20 Aug 1999
Handle: RePEc:wpa:wuwpga:9810001

Note: Type of Document - Acrobat PDF; prepared on PC; pages: 37 ; figures: included
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Web page: http://128.118.178.162

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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  1. Mirman, L.J. & Samuelson, L. & Schlee, E.E., 1991. "Strategic information manipulation in duopolies," Discussion Paper 1991-37, Tilburg University, Center for Economic Research.
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  3. Kenneth Burdett and Melvyn G. Coles, . "Steady State Price Distributions in a Noisy Search Equilibrium," Economics Discussion Papers 450, University of Essex, Department of Economics.
  4. repec:att:wimass:9206 is not listed on IDEAS
  5. Jennifer F. Reinganum, 1978. "A Simple Model of Equilibrium Price Dispersion," Discussion Papers 335, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  6. Michael H. Riordan, 1985. "Imperfect Information and Dynamic Conjectural Variations," RAND Journal of Economics, The RAND Corporation, vol. 16(1), pages 41-50, Spring.
  7. Dirk Bergemann & Juuso Valimaki, 1996. "Market Diffusion with Two-Sided Learning," Cowles Foundation Discussion Papers 1138, Cowles Foundation for Research in Economics, Yale University.
  8. 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.
  9. Fishman, Arthur & Rob, Rafael, 1998. "Experimentation and Competition," Journal of Economic Theory, Elsevier, vol. 78(2), pages 299-320, February.
  10. Aghion, Philippe & Espinosa, Maria Paz & Jullien, Bruno, 1993. "Dynamic Duopoly with Learning through Market Experimentation," Economic Theory, Springer, vol. 3(3), pages 517-39, July.
  11. Mirman, Leonard J & Samuelson, Larry & Urbano, Amparo, 1993. "Duopoly Signal Jamming," Economic Theory, Springer, vol. 3(1), pages 129-49, January.
  12. Salop, Steven & Stiglitz, Joseph E, 1977. "Bargains and Ripoffs: A Model of Monopolistically Competitive Price Dispersion," Review of Economic Studies, Wiley Blackwell, vol. 44(3), pages 493-510, October.
  13. Gale, D. & Chamley, C., 1992. "Information Revelation and Strategic Delay in a Model of Investment," Papers 10, Boston University - Department of Economics.
  14. Caplin, Andrew & Leahy, John V, 1993. "Sectoral Shocks, Learning, and Aggregate Fluctuations," Review of Economic Studies, Wiley Blackwell, vol. 60(4), pages 777-94, October.
  15. 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.
  16. Christopher Harris, 1993. "Generalized Solutions of Stochastic Differential Games in One Dimension," Papers 0044, Boston University - Industry Studies Programme.
  17. Harrington Jr. , Joseph E., 1995. "Experimentation and Learning in a Differentiated-Products Duopoly," Journal of Economic Theory, Elsevier, vol. 66(1), pages 275-288, June.
  18. Keller, Godfrey & Rady, Sven, 1999. "Optimal Experimentation in a Changing Environment," Review of Economic Studies, Wiley Blackwell, vol. 66(3), pages 475-507, July.
  19. Peter Diamond, 1985. "Consumer Differences and Prices in a Search Model," Working papers 404, Massachusetts Institute of Technology (MIT), Department of Economics.
  20. Patrick Bolton & Christopher Harris, 1999. "Strategic Experimentation," Econometrica, Econometric Society, vol. 67(2), pages 349-374, March.
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  24. McLennan, Andrew, 1984. "Price dispersion and incomplete learning in the long run," Journal of Economic Dynamics and Control, Elsevier, vol. 7(3), pages 331-347, September.
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Citations

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Cited by:
  1. Dirk Bergemann & Juuso Valimaki, 1999. "Entry and Innovation in Vertically Differentiated Markets," Discussion Papers 1260, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. Dirk Bergemann & Valimaki Juuso, 2001. "Entry and Vertical Differentiation," Cowles Foundation Discussion Papers 1302, Cowles Foundation for Research in Economics, Yale University.
  3. Heski Bar-Isaac, 2001. "Self-confidence and survival," LSE Research Online Documents on Economics 19329, London School of Economics and Political Science, LSE Library.

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