Imperfect Information and Dynamic Conjectural Variations

This article analyzes oligopoly interaction in an environment where firms are imperfectly informed about the evolution of the market demand curve. The analysis develops a two-period Cournot framework under the assumptions that demand shifts are positively serially correlated, that firms never directly observe the demand curve, and that firms never observe the previous quantity decisions of rivals. Firms do draw inferences about the position of the demand curve from past observations on prices. Consequently, the current output of a firm will influence the current market price, which will then influence rivals' inferences about future demand. The future output decisions of rivals will respond accordingly. The theory predicts negative dynamic conjectural variations. Essentially, a firm perceives that an increase in its output will lower the current market-clearing price, which will cause rival firms to think that the demand curve has shifted down and hence induce them to lower their outputs in the future.