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Price Dispersion and Learning in a Dynamic Differentiated Goods-Duopoly

(by Sven Rady, with Godfrey Keller)

 

RAND Journal of Economics 34(1), Spring 2003, pp. 139-166

Circulated as:
Munich Department of Economics Discussion Paper No. 01-10
CEPR Discussion Paper No. 2919

An earlier version of this work was circulated as Stanford GSB Research Paper No. 1529R and STICERD Discussion Paper No. TE/99/369 under the title "Market Experimentation in a Dynamic Differentiated-Goods Duopoly".

Abstract
We study the evolution of prices set by duopolists who are uncertain about the perceived degree of product differentiation. Customers sometimes view the products as close substitutes, sometimes as highly differentiated. As the informativeness of the quantities sold increases with the price differential, there is scope for active learning by firms. When information has low value to the firms, they 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. Such price dispersion arises in a cyclical fashion, and is most likely to be observed when the firms' environment changes sufficiently often, but not too frequently. Firms' payoffs are higher when they use correlated pricing strategies. Contrary to what one might expect, such coordination need not hurt consumers, provided they are sufficiently impatient.

Keywords: Duopoly Experimentation, Bayesian Learning, Stochastic Differential Game, Markov Perfect Equilibrium, Mixed Strategies, Correlated Equilibrium
JEL Classification: C73, D43, D83

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