Equilibrium Price Distributions

Abstract

Equilibrium price distributions (for a homogeneous product) consistent with individual incentives are investigated. They arise in informationally imperfect markets in which the only primitive datum is the distribution of search costs. It is shown that single, multi- and continuous price distributions are all viable long-run phenomena depending on the nature of search costs. A method for computing equilibrium price distributions is also provided. Jevons' law of one price has long been an accepted dictum in economic theory. In a classroom presentation, it still serves (sometimes implicitly) as a major premise in many micro-models of market interaction. Much of the descriptive theory as well as welfare analysis hinges on this assumption. Yet, one's day to day experience reveals that price differentials are a viable phenomenon and that looking for lower prices may very well be a rewarding activity. The prospects of eventually hitting a bargain and the resulting price reduction would more than compensate for the cost incurred during the search process. Moreover, the existence of price dispersions appear to be an empirically stable phenomenon. Snapshots of markets for relatively homogeneous products reveal substantial and recurring price differentials. Stigler (1961) and Pratt, Wise and Zeckhauser (1979) for example, report some evidence supporting this claim. An important article by Stigler (1961) focused economists' attention on the crucial role played by the informational structure of markets. It gave rise to the study of the