matt12 - Lecture 12 Search and price dispersion EC 105...

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Lecture 12: Search and price dispersion EC 105. Industrial Organization. Fall 2011 Matt Shum HSS, California Institute of Technology September 9, 2011 EC 105. Industrial Organization. Fall 2011 (Matt Shum HSS, California Institute of Technology) Lecture 12: Search and price dispersion September 9, 2011 1 / 25
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Outline Outline 1 Nonsequential vs. sequential search 2 Nonsequential search model 3 Nonsequential search 4 Sequential search model EC 105. Industrial Organization. Fall 2011 (Matt Shum HSS, California Institute of Technology) Lecture 12: Search and price dispersion September 9, 2011 2 / 25
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Outline Why are prices for the same item so different across stores? HONG AND SHUM / 259 FIGURE 1 RAW HISTOGRAMS OF ONLINE PRICES A puzzle considering basic economic theory: review this. Consider the benchmark of perfect competition EC 105. Industrial Organization. Fall 2011 (Matt Shum HSS, California Institute of Technology) Lecture 12: Search and price dispersion September 9, 2011 3 / 25
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Outline Leaving the PC world One important implicit assumption of PC paradigm is that consumers are aware of prices at all stores. This implies an infinitely elastic demand curve facing firms. (ie. if one firm raises prices slightly, he will lose all demand). Obviously, this assumption is not realistic. Here we consider what happens, if we relax just this assumption, but maintain other assumptions of PC paradigm: large #firms, perfect substitutes, etc. EC 105. Industrial Organization. Fall 2011 (Matt Shum HSS, California Institute of Technology) Lecture 12: Search and price dispersion September 9, 2011 4 / 25
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Outline Search model Each consumer demands one unit; Starts out at one store, incurs cost c > 0 to search at any other store. Consumer only knows prices at stores that she has been to, and buys from the canvassed store with the lowest price. “free recall” Utility u from purchasing product: demand function is purchase if p u don’t purchase otherwise (1) What is equilibrium in this market? EC 105. Industrial Organization. Fall 2011 (Matt Shum HSS, California Institute of Technology) Lecture 12: Search and price dispersion September 9, 2011 5 / 25
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Outline Diamond paradox Claim: a nonzero search cost c > 0 leads to equilibrium price equal to u (“monopoly price”) Assume that marginal cost=0, so that under PC, p = 0 n firms, with n large. Consumers equally distributed initially among all firms. Start out with all firms at PC outcome. What happens if one firm deviates, and charges some p 1 such that 0 < p 1 < c ? Consumers at this store? Consumers at other stores? How will other stores respond? By iterating this reasoning .... EC 105. Industrial Organization. Fall 2011 (Matt Shum HSS, California Institute of Technology) Lecture 12: Search and price dispersion September 9, 2011 6 / 25
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Outline Now start at “monopoly outcome”, where all firms are charging u .
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