Search and Price Dispersion in Oligopolies
33 Pages Posted: 7 Aug 2019 Last revised: 8 Mar 2020
Date Written: February 26, 2020
We explore equilibrium price dispersion in an oligopolistic product market with search frictions. Consumers know prices, but due to informational frictions, search is random. The distinct feature of our theory is that consumers’ aggregate demand functions are obtained endogenously. We show that price dispersion generically arises if firms have a heterogeneous price impact on consumers’ search strategy, resulting in demand curves with different price elasticities. Otherwise, cost heterogeneity is required. Crucially, this phenomenon only emerges if there is heterogeneity on both sides of the market. As frictions vanish, so does price dispersion, resolving Diamond’s paradox. However, dispersion might not fall monotonically. In cases of only one-sided heterogeneity, demand curves are shown to be equally elastic, resulting in a unique equilibrium without dispersion. In particular, if consumers are homogeneous, demand curves are infinitely inelastic, and so, all firms charge the monopolistic price. Our theory provides a common explanation — built on the endogenous demand price elasticity properties— for how heterogeneity leads to price dispersion.
Keywords: Search Theory, Price Dispersion, Dynamic Programming
JEL Classification: D21, D43, D25, D83
Suggested Citation: Suggested Citation