Imperfect Competition as a Result of Unawareness

Abstract

This paper develops a dynamic model of price competition where buyers have constrained consideration sets due to unawareness. There are two sellers: an incumbent, who is initially more well-known among buyers, and an entrant. Awareness is influenced by word-of-mouth: if more buyers choose to shop at a seller, unaware buyers are more likely to discover that seller. In the unique equilibrium, both sellers randomize their pricing strategies, but one seller posts higher expected prices than the other. I show that if the incumbent’s present actions can change the future state of the market to a high enough degree, he has a strong incentive to undercut the entrant. Thus, this model provides microfoundations to the concept of “advantage denying” motive and relates it to the empirical finding that it takes time for a seller’s demand to grow.

Keywords: Unawareness, price competition, discovery, equilibrium price dispersion.

JEL Classification: D43, D83