Experimenting to Learn about Demand in Duopoly with Forward-Looking Consumers

Using a two-period model, I show that competition between two symmetric duopolists trying to learn about unknown features of demand results in an informationally suboptimal process. Because a firm's marginal return to price experimentation equals zero if the rival's price is matched in the first period, myopic symmetric pricing arises in equilibrium even though a firm's expected second-period profit attains a local minimum. Furthermore, forward-looking consumers suffer from ratcheting because their first-period purchase decisions partly reveal their preferences, which exacerbates the informational suboptimality of the firms' experimentation process without affecting their pricing. The role of firm asymmetries is also analyzed.