Scandinavian Working Papers in Economics

Working Papers,
Lund University, Department of Economics

No 2007:6: Setting the Anchor: Price Competition, Level-n Theory and Communication

Erik Wengström ()
Additional contact information
Erik Wengström: Department of Economics, Lund University, Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund, Sweden

Abstract: This paper analyzes communication from the viewpoint of the level-n theory of bounded rationality. It examines if communication can be understood by the effect it has on high-level types’ beliefs about the actions of simpleminded level-0 players. We present experimental evidence from a slightly perturbed price competition game designed to test this interpretation. The main finding is that communication affects subjects in a way that seems compatible with the level-n model, indicating that people lie in order to fool other players that they believe do less thinking. Moreover, the results indicate that the predictive power of the level-n model does crucially depend on the possibility for high level players to form homogenous beliefs about the behavior of the level-0 players.

Keywords: Noncooperative Game Theory; Communication; Bounded Rationality; Experiments

JEL-codes: C72; C92; D84

29 pages, March 20, 2007

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