Abstract:
In this paper we study a model of a quantity-setting duopoly market where firms leek
knowledge of the market, demand. Using a misspecified demand function firms determine
their profit-maximizing choices of their corresponding perceived market game. For
illustrative purposes we assume that, the (true) demand function is linear and that till'
reaction functions of the players are quadretic. We then investigate the global dynamics
of this game and characterize the number of steady states und their welfare properties.
We study the basins of attraction of these steady states and present situations in which
global bifurcations of their basins occur when model parameters are varied. The economic
significance of our result is to show that in situations where players choose their
actions based on a misspecified model of the environment, additional self-confirming
steady states may emerge, despite the fact that the Nash-equilibrium of the game under
perfect knowledge is unique. As a consequence the long run outcome of the game and
overall welfare is highlv dependent upon initial conditions.
