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Market experimentation in a dynamic differentiated-goods duopoly

R Keller () and Sven Rady ()

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

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.

Keywords: Duopoly experimentation; Bayesian learning; stochastic differential game; Markov-perfect equilibrium; mixed strategies; correlated equilibrium (search for similar items in EconPapers)
JEL-codes: D83 C73 D43 (search for similar items in EconPapers)
Pages: 38 pages
Date: 1999-07
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http://eprints.lse.ac.uk/19346/ Open access version. (application/pdf)

Related works:
Working Paper: Market Experimentation in a Dynamic Differentiated-Goods Duopoly (1999) Downloads
Working Paper: Market Experimentation in a Dynamic Differentiated-Goods Duopoly (1999) Downloads
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