COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 1138

Market Diffusion with Two-Sided Learning

Dirk Bergemann and Juuso Välimäki

November 1996

The diffusion of a new product of uncertain value is analyzed in a duopolistic market in continuous time. The two sides of the market, buyers and sellers, learn the true value of the new product over time as a result of experimentation. Buyers have heterogeneous preferences over the products and sellers compete in prices.

The pricing policies and market shares of the sellers in the unique Markov perfect equilibrium are obtained explicitly. The dynamics of the equilibrium market shares display excessive sales of the new product relative to the social optimum in early stages and too low sales later on. The dynamic resolution of uncertainty implies ex post differentiation and hence both sellers value information positively. As information is generated only by experiments with the new product, this relaxes the price competition in the dynamic setting. Finally, the diffusion path of a successful product is shown to be S-shaped.