Collaborative Research: New Applications of Dynamic Games with Asymmetric Information: Mergers, Capacity Discipline and Price Rigidity

Purdue University, West Lafayette IN

Investigators

Abstract

This research investigates how asymmetric information between firms can affect prices and consumer welfare, and how antitrust policies might be changed to account for these effects. Currently almost all analyses of markets -- whether to quantify market power or perform counterfactuals -- assume complete information, in which all firms know the demand, the marginal costs and the objectives of their rivals exactly. However, if firms know more about their own positions, then they might try to use their pricing or capacity choices to influence what their rivals believe in order to affect how those rivals might behave in the future. Some simple examples suggest that even small amounts of asymmetric information can distort prices significantly, and potentially explain why prices rise significantly after mergers; why prices appear rigid even when menu costs should be small; and, why some industries, such as airlines, appear to go through periods of capacity discipline. This research will make theoretical, empirical and methodological contributions. The investigators first characterize non-collusive Markov Perfect Bayesian equilibria in multi-period oligopoly pricing, bidding and capacity choice games with asymmetric information. The project further develops computational methods to solve such equilibria, which often require solving very large numbers of differential equations. The associated code will be made available to other researchers. The investigators also test and calibrate the models using scanner data on consumer packaged goods and data on capacity investments in airline markets. In addition, the project analyzes changes in prices and firm behavior around actual mergers to understand whether asymmetric information can explain why outcomes were significantly different from what the antitrust authorities expected when the mergers were approved. Lastly, this research trains graduate students so that they can use these and other techniques in their own research.