Price dynamics and quality in information markets

Abstract We explore the price dynamics of a vertically differentiated market in which two or more sellers compete to provide an information good or service to a population of buyers. Each seller offers the good or service at a fixed level of “quality”, and attempts to set its price in such a way that it maximizes its own profit. Five different seller pricing strategies, ranging widely from ones that require perfect knowledge and unlimited computational power to ones that require very little knowledge or computational capability, are employed in two different buyer populations. The resulting collective dynamics are studied using a combination of analysis and simulation. In a population of quality-sensitive buyers, all pricing strategies lead to a price equilibrium predicted by a game-theoretic analysis. However, in a population of price-sensitive buyers, most pricing strategies lead to large-amplitude cyclical price wars. The circumstances under which cyclical price wars occur can be explained in terms of the topology of an underlying “profit landscape” [J.O. Kephart, J.E. Hanson, J. Sairamesh, Price and niche wars in a free-market economy of software agents, Artificial Life Journal, 4(1), 1998, 1–23].