Sequential Search with Incompletely Informed Consumers: Theory and Evidence from Retail Gasoline Markets

A large variety of markets, such as retail markets for gasoline or mortgage markets, are characterized by a small number of firms offering a fairly homogenous product at virtually the same cost, while consumers, being uninformed about this cost, sequentially search for low prices. The present paper provides a theoretical examination of this type of market, and confronts the theory with data on retail gasoline prices. We develop a sequential search model with incomplete information and characterize a perfect Bayesian equilibrium in which consumers follow simple reservation price strategies. Firms strategically exploit consumers being uninformed about their production cost, and set on average higher prices compared to the standard complete information model. Thus, consumer welfare is lower. Using data on the gasoline retail market in Vienna (Austria), we further argue that incomplete information is a necessary feature to explain observed gasoline prices within a sequential search framework. JEL Classification: D40; D83; L13