A Model of Two Learning Processes

Abstract

Many studies have shown that consumers, before deciding whether to purchase a new product or service, draw inferences from the choices of other consumers and actively acquire information from other sources. We propose a novel model that integrates two learning processes: observational learning and active learning. Building upon the classic observational learning framework, this model allows each consumer to make dynamic choices of information acquisition. We first analyze consumers' learning behavior in the presence of a given price, and then we endogenize the seller's dynamic pricing strategy in response to the two learning processes of consumers. We show that a forward-looking seller may find it optimal to sacrifice short-term profits by setting a higher price to induce active learning, thereby improving the information transmitted through observational learning and ultimately gaining higher expected future profits. We also investigate consumers' learning behavior, the seller's dynamic pricing strategy, and long-run market learning outcomes when the speed of information acquisition increases with sales.

Keywords: observational learning, information acquisition, word of mouth, dynamic pricing