Monopoly experimentation

Abstract

This paper considers a firm facing an uncertain demand curve. The firm can experimentally adjust its output in order to gain information that willincrease expected future profits. We examine two basic questions. Under whatconditions is it worthwhile for the firm to experiment? How does the firmadjust its output away from the myopic optimism to exploit its ability to experiment? Two necessary conditions are established for experimentation tooccur, involving requirements that experimentation be informative and thatinformation be valuable. Conditions are then established for experimentationto induce the firm to increase or decrease quantity. These results, whichcontain several previous analyses as special cases, provide an understanding of experimentation that will be useful in a number of applications.