Pricing Routines and Industrial Dynamics

We propose an evolutionary model in which boundedly-rational firms compete and learn in a dynamic oligopoly with imperfect information and evolving degrees of market power. Firms in the model set prices according to distinct routines, and they try to make profits by capturing market share. The demand-side of the market is composed of consumers who are boundedly-rational, experience externalities, and are capable of learning and adapting to changing market options. Supply-demand market interactions can be represented through a population dynamics model from which prices and market structures endogenously emerge. We obtain closed-form results which we can interpret and compare with benchmark results obtained from a standard non-cooperative game (Bertrand). We explore the Bertrand game in a (one-shot) “prisoner dilemma” setting, with fully-rational agents, and perfect information. We also explore the Bertrand-repeated game. When we compare the results from the evolutionary model, with the extremely different outcomes arising from the Bertrand setting, we find a surprising result. Whereas in the fully-rational (Bertrand) setting firms either lower prices and destroy their profits, or try to cooperate in a collusive equilibrium which -apart from being unstable- erodes consumer welfare, in the evolutionary setting, firms make profits, co-exist competing with moderate prices and the dynamics improve consumer welfare. As we will see, the evolutionary outcomes are not only more enlightening and sustainable, but they also seem to entail higher levels of firm and consumer welfare. These results lead us to claim that, instead of being “market failures”, such features as evolving market power, heterogeneity of agents facing uncertainty, externalities and asymmetric information are, precisely, the key traits which make markets work. If this were so, we argue that evolutionary Neo-Schumpeterian models can incorporate these features altogether, thus leading towards a more realistic price theory for market economies.