Just Starting Out: Learning and Equilibrium in a New Market

71 Pages Posted: 15 Feb 2016

See all articles by Ulrich Doraszelski

Ulrich Doraszelski

Harvard University - Department of Economics; University of Pennsylvania - Business & Public Policy Department

Gregory Lewis

Microsoft Corporation - Microsoft Research New England

Ariel Pakes

National Bureau of Economic Research (NBER); Harvard University - Department of Economics

Date Written: February 2016

Abstract

We document the evolution of the newly created market for frequency response within the UK electricity system over a six-year period. Firms competed in price while facing considerable initial uncertainty about market demand and rival behavior. We show that over time prices stabilized, converging to a rest point that is consistent with equilibrium play, and then adjusted to subsequent changes in the market quite quickly. We draw on models of fictitious play and adaptive learning to analyze how this convergence occurs and show that these models predict behavior better than Nash equilibrium prior to convergence.

Suggested Citation

Doraszelski, Ulrich and Lewis, Gregory and Pakes, Ariel, Just Starting Out: Learning and Equilibrium in a New Market (February 2016). NBER Working Paper No. w21996. Available at SSRN: https://ssrn.com/abstract=2732473

Ulrich Doraszelski (Contact Author)

Harvard University - Department of Economics ( email )

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University of Pennsylvania - Business & Public Policy Department

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Gregory Lewis

Microsoft Corporation - Microsoft Research New England ( email )

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Ariel Pakes

National Bureau of Economic Research (NBER) ( email )

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Harvard University - Department of Economics ( email )

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