Experimentation and Learning in a Differentiated-Products Duopoly

This paper explores price-setting behavior in the context of a duopoly in which firms are uncertain about the degree of product differentiation. Firms learn from the difference in their realized demands in light of the price differential. The informativeness of this market experiment is shown to be increasing in size of the price differential. In markets with highly substitutable products, price dispersion is enhanced as firms adjust their prices so as to generate more information. In markets with highly differentiated products, firms compress their prices as they prefer to reveal less about the extent of product differentiation. Journal of Economic Literature Classification Numbers D43, D83, L13.