Just Starting Out: Learning and Price Competition in a New Market

Economists model strategic interactions using the tools of game theory. The concept of Nash Equilibrium is central. Yet for predictive purposes, it is necessary to know how agents behave out-of-equilibrium, for example when a placed in a new strategic situation. This paper offers a case study of the frequency response market in the UK. Following deregulation, electricity firms were required to compete on price in an otherwise stable environment. We show that prices converge over time, and argue that the rest point constitutes a static Nash equilibrium. We examine how well models of learning do in predicting play during the period prior to convergence. Models in which firms expect their rivals to behave as they did in the recent past fit better than those that take into account rival play over a longer time horizon. We also find evidence of statistical learning about the underlying demand parameters conditional on competitors’ play. A model that combines these two features fits quite well: it is able to explain 37% of the share-weighted variation in prices, even though none of the model parameters are chosen to fit the pricing behavior.

Speaker Details

Greg Lewis is associate professor of economics at Harvard University, and faculty research fellow at the National Bureau of Economic Research. His main research interests lie in industrial organization, market design and applied econometrics. Recently, his time has been spent analyzing strategic learning by firms in the British electricity market, suggesting randomized mechanisms for price discrimination in online display advertising, developing econometric models of auction markets, and evaluating the design of procurement auctions. He received his bachelor’s degree in economics and statistics from the University of the Witwatersrand in South Africa, and his MA and PhD both from the University of Michigan.

Date:
Speakers:
Greg Lewis
Affiliation:
Harvard