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

Опубликовано 21 июня 2016, 20:34

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.