An experiment on spatial competition with endogenous pricing

Abstract

a b s t r a c t Hotelling's (1929) principle of minimum differentiation and the alternative prediction that firms will maximally differentiate from their rivals in order to relax price competition have not been explicitly tested so far. We report results from experimental spatial duopolies designed to address this issue. The levels of product differentiation observed are systematically lower than predicted in equilibrium under risk neutrality and compatible with risk aversion. The observed prices are consistent with collusion attempts. Our main findings are robust to variations in three experimental conditions: automated vs. human market sharing rule for ties, individual vs. collective decision making, and even vs. odd number of locations.

Interaction effects between consumer information and firms' decision rules in a duopoly: how cognitive features can impact market dynamics

“…In addition of these theoretical results, several experimental studies show that by manipulating either the communication between firms (Kruse et al, 2000) or by manipulating the time structure (Kephart and Friedman, 2015)-what also indirectly impacted the ability of the firms to communicate about their intentions-it was possible to induce either a minimal or a maximal differentiation between the firms. Similarly to Kruse et al (2000) and Kephart and Friedman (2015), and despite the robustness of the minimal differentiation principle highlighted by the experimental results of Huck et al (2002) and Barreda-Tarrazona et al (2011), our results report both phenomena: simulations and experiments allowed us to demonstrate that the consumers' amount of information affects the differentiation of firms with respect to their decision-making strategies. We isolated incentives supporting either a geographic concentration and a fierce price competition resulting in drastic reduction of profits, or a maximal differentiation inducing a softening of the price competition and thereby a large increase in firms' profits.…”

“…These two findings brought together suggest that quick and/or full information transmission can help to reach a cooperative equilibrium in a typical Hotelling's model. Several other studies brought up arguments supporting the robustness of the minimal differentiation phenomenon such as, for example, the four-player version of the game by Huck et al (2002) or in Barreda-Tarrazona et al (2011), where subjects tended to group in the center under several experimental conditions. Although there is a treatment in Barreda-Tarrazona et al (2011) with human subjects as consumers, what is common to all these works is their shared assumption of the fact that firms are competing to capture rational and fully informed consumers even when they document spatial behavior that departs from Nash equilibrium when it theoretically exists.…”

“…Several other studies brought up arguments supporting the robustness of the minimal differentiation phenomenon such as, for example, the four-player version of the game by Huck et al (2002) or in Barreda-Tarrazona et al (2011), where subjects tended to group in the center under several experimental conditions. Although there is a treatment in Barreda-Tarrazona et al (2011) with human subjects as consumers, what is common to all these works is their shared assumption of the fact that firms are competing to capture rational and fully informed consumers even when they document spatial behavior that departs from Nash equilibrium when it theoretically exists. The case when consumers have no full informational access to the firms' strategies and when firms must compete over this less than completely informed consumers have not been addressed, to our knowledge, in the experimental literature related to Hotelling (1929).…”

Oligopoly Experiments in the Current Millennium

“…The leitmotif across many of the above‐mentioned studies is that comparative statics are very much in line with mixed‐strategy predictions. However, outcomes often differ quite substantially from point predictions, particularly if buyers are human players rather than computerized robots (see Cason and Mago, ; Barreda‐Tarrazona et al ., ). For example, sellers in Morgan et al .…”

“…Alternatively, products may look identical at the surface, but are in fact differentiated due to, for example, differences in location, advertising or customer service. Under spatial price competition, for example, firms are typically predicted to randomize their pricing strategies as well (at least, under certain conditions), and experimental evidence supports these predictions (Orzen and Sefton, ; Peeters and Strobel, ; Barreda‐Tarrazona et al ., )…”