Bounded rationality, dynamic oligopoly, and conjectural variations

Abstract We propose a dynamic model of n-firm oligopoly that provides a logically consistent reinterpretation of conjectural variations. Each firm solves a dynamic optimization problem believing that the other firms will alter their future choices in proportion to its own current change. These beliefs adapt in light of observed behavior. We show that steady state equilibria can range from complete cooperation to predatory play and provide conditions under which the firms’ behavior and beliefs converge to a steady state. The sufficient conditions for stability are more easily satisfied the smaller the cross-effects among firms through demand or belief parameters. They are also more easily satisfied in a price setting than in a quantity setting, differentiated products model.