Adaptive Learning Models of Consumer Behaviour

This paper applies recent advances in the theory of learning to the analysis of consumer behaviour in a dynamic duopoly. Nash equilibrium play is characterized when consumers learn adaptively about the relative quality of the two products. A contrast is made between belief-based and reinforcement learning. Under reinforcement learning, consumers can become locked into the habit of purchasing inferior goods. Such lock-in permits the existence of multiple history-dependent asymmetric steady states in which one firm dominates. In contrast, belief-based learning rules must lead asymptotically to correct beliefs about the relative quality of the two brands and so in this case there is a unique steady state. However, if consumers' initial estimate of the firm's quality is high (low), a firm has an incentive to charge above (below) the mytopic duopoly price in order to slow (speed up) learning.