LEARNING AND STRATEGIC PRICING

We consider the situation where a single consumer buys a stream of goo ds from different sellers over time. The true value of each seller's p roduct to the buyer is initially unknown. Additional information can b e gained only by experimentation. For exogeneously given prices the bu yer's problem is a multi-armed bandit problem. The innovation in this paper is to endogenize the cost of experimentation to the consumer by allowing for price competition between the sellers. The role of prices is then to allocate intertemporally the costs and benefits of learnin g between buyer and sellers. We examine how strategic aspects of the o ligopoly model interact with the learning process. All Markov perfect equilibria (MPE) are efficient. We identify an equilibrium which besid es its unique robustness properties has a strikingly simple, seemingly myopic pricing rule. Prices below marginal cost emerge naturally to s ustain experimentation. Intertemporal exchange of the gains of learnin g is necessary to support efficient experimentation. We analyze the as ymptotic behavior of the equilibria.