Herding Prices: Social Learning and Dynamic Competition in Duopoly

Abstract

We embed observational learning (BHW) in a symmetric duopoly with random arrivals and search frictions. With fixed posted prices, a mixed-strategy pricing equilibrium exists and yields price dispersion even with ex-ante identical firms. We provide closed-form cascade bands and show wrong cascades occur with positive probability for interior parameters, vanishing as signals become precise or search costs fall; absorption probabilities are invariant to the arrival rate. In equilibrium, the support of mixed prices is connected and overlapping; its width shrinks with signal precision and expands with search costs, and mean prices comove accordingly. Under Calvo price resets (Poisson opportunities), stationary dispersion and mean prices fall; when signals are sufficiently informative, wrong-cascade risk also declines. On welfare, a state-contingent Pigouvian search subsidy implements the planner's cutoff. Prominence (biased first visits) softens competition and depresses welfare; neutral prominence is ex-ante optimal.