Equilibrium Price Dispersion with Sequential Search

Diamond's 'paradox' (1971) showed that in a market where consumers search sequentially and have strictly positive search costs the unique price equilibrium is where all firms charge the monopoly price. This paper demonstrates that Diamond's result depends crucially on the assumption of single commodity search and does not persist when the model is generalised to allow multi-commodity search. A model is presented where identical consumers search optimally (sequentially) and with positive search costs for two commodities. Firms supply only one of the commodity types so consumers are required to sample at least two firms to satisfy their consumption requirements. Within industries firms are identical, producing a homogenous product at the same, constant, marginal cost. The equilibrium is shown to display price dispersion, in fact no two firms charge the same price with positive probability. Comparative statics are conducted and it is demonstrated that the price dispersion depends solely on the search behaviour of consumers, converging to the competitive price as search costs converge to zero. Changes in industry demand effect equilibrium prices only through the indirect impact the change in demand has on the consumers' search behaviour.