Competition As a Test of Hypotheses: Simulation of Knowledge-Generating Market Processes

Hayek's well-known evolutionary concept of "competition as a discovery procedure" can be characterized as a parallel process of experimentation, in which rivalrous firms generate and test hypotheses about the best way to fulfill the consumers' preferences. Through this permanent process of variation and selection of hypotheses (innovation / imitation) a process of knowledge accumulation can take place. The central aim of our paper is to model the basic Hayekian learning mechanism, which consists of experimentation and mutual learning, and to ask for determinants of the rapidity of knowledge accumulation. In our multilevel simulation model, on the micro level, firms create new hypotheses through mutation. On the macro level, on the market, these hypotheses meet and the best firm is determined. All firms then imitate the best firm. In our model, 100 of these periods which consist of an innovation and an imitation phase are simulated. We presume that decentrality is crucial for the working of the knowledge-generating process, because a larger number of independently innovating firms leads to more experimentation. We investigate into the impact of firm concentration, the impact of the decentralization of firms, as well as the impact of impediments in imitation like lock-ins on the growth rate of knowledge accumulation. Our simulation results show that the number of firms is positively correlated with the rapidity of knowledge accumulation suggesting a new argument for a critical assessment of mergers in competition policy.