Information Frictions and Market Power: A Laboratory Study

Abstract

In a laboratory experiment with supply function competition with private information about correlated costs we study whether cost interdependence and the precision of the private information are related to market power in the ways predicted by Bayesian supply function equilibrium. We find that with uncorrelated costs, observed behavior is close to the theoretical benchmark regardless of the signal precision. However, with interdependent costs and precise private signals, market power does not raise above the case of uncorrelated costs, contrary to the theoretical prediction. By contrast, if private signals are noisy then market power is, as predicted by theory, significantly higher than with uncorrelated costs, but the size of the increase in market power is moderate. Our results are consistent with a rational inattention view.