Price Wars in Price-Setting Supergames

This paper presents a method of generating price wars in price-setting supergames. The market is one where symmetric oligopolists produce a differentiated product and use price as a strategic variable. Prices are posted and can be observed by all. There is, thus, little uncertainty or scope for secret price cutting. Nevertheless, price wars occur; they are precipitated by periodic, but infrequent, demand shocks. Firms use the wars to learn about changed conditions in the market so that they can calculate the new stationary Nash equilibrium. Learning is modeled in a Bayesian fashion via the Kalman filter.