Equilibrium price dispersion with sequential search

The paper studies equilibrium pricing in a product market for an indivisible good where buyers search for sellers. Buyers search sequentially for sellers but do not meet every seller with the same probability. Specifically, a fraction of the buyers’ meetings lead to one particular large seller, while the remaining meetings lead to one of a continuum of small sellers. In this environment, the small sellers would like to set a price that makes the buyers indifferent between purchasing the good and searching for another seller. The large seller would like to price the small sellers out of the market by posting a price that is low enough to induce buyers not to purchase from the small sellers. These incentives give rise to a game of cat-and-mouse, whose only equilibrium involves mixed strategies for both the large and the small sellers. The fact that the small sellers play mixed strategies implies that there is price dispersion. The fact that the large seller plays mixed strategies implies that prices and allocations vary over time. We show that the fraction of the gains from trade accruing to the buyers is positive and nonmonotonic in the degree of market power of the large seller. As long as the large seller has some positive but incomplete market power, the fraction of the gains from trade accruing to the buyers depends in a natural way on the extent of search frictions. © 2015 Elsevier Inc. All rights reserved. JEL classification: D21; D43 ✩ The authors are grateful to the editor, Ricardo Lagos, and to three anonymous referees for many useful suggestions. The authors also thank Mike Golosov, Hugo Hopenhayn, Dale Mortensen, Giuseppe Moscarini, Randy Wright, seminar participants at the Federal Reserve Bank of Richmond and at the Einaudi Institute for Economics and Finance, conference participants at the Society of Economic Dynamics (Toronto 2014) and the NBER Summer Institute (Cambridge 2014) for their comments. The views expressed in this paper are those of the authors and do not necessarily represent the views of the Federal Reserve Bank of Richmond or the Federal Reserve System. * Corresponding author. E-mail addresses: [email protected] (G. Menzio), [email protected] (N. Trachter). http://dx.doi.org/10.1016/j.jet.2015.09.004 0022-0531/© 2015 Elsevier Inc. All rights reserved. G. Menzio, N. Trachter / Journal of Economic Theory 160 (2015) 188–215 189