Experimentation and Competition

This paper examines the effect of competition on firms’ efforts to experiment and learn about market demand. Consumers are assumed to know prices only at sellers they have actually visited, but must bear search costs to find the prices of other sellers. Under these conditions we show that firms’ incentives to experiment are diluted by comparison with the monopoly case and that this effect is stronger the smaller the search cost. The learning environment we portray gives rise to several time paths which have been empirically documented, including penetration pricing, cream-skimming and cyclical pricing.

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