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Market Experimentation in a Dynamic Differentiated-Goods Duopoly

40 Pages Posted: 16 Jul 2008  

Godfrey Keller

University of Oxford - Department of Economics

Sven Rady

University of Bonn

Date Written: July 1999

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.

JEL Classification: D20, D80, H11, H70, L22, P11

Suggested Citation

Keller, Godfrey and Rady, Sven, Market Experimentation in a Dynamic Differentiated-Goods Duopoly (July 1999). LSE STICERD Research Paper No. TE369. Available at SSRN: https://ssrn.com/abstract=1160967

Godfrey Keller (Contact Author)

University of Oxford - Department of Economics ( email )

Manor Road Building
Manor Road
Oxford, OX1 3BJ
United Kingdom
+44 20 1865 281173 (Phone)

Sven Rady

University of Bonn ( email )

Regina-Pacis-Weg 3
Postfach 2220
Bonn, D-53012
Germany

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