Imperfect Competition as a Result of Unawareness

Abstract

Suppose that sellers compete for a continuum of buyers in a market and buyers’ consideration sets are constrained due to unawareness. Awareness evolves over time and is influenced by word-of-mouth: if more buyers choose to shop at one seller, then unaware buyers are more likely to discover that seller. There are two sellers: the Incumbent who enters the market before the Entrant. In the unique equilibrium, both sellers randomize their pricing strategies, but one seller posts higher expected prices than the other. If both sellers are large compared with the size of the market and the elasticity of awareness to sales is large, then the Entrant’s distribution of prices first-order stochastically dominates the Incumbent’s: if the Incumbent’s present actions change the future equilibrium path to a large enough degree, then they have incentives to undercut the Entrant to reduce the number of buyers who discover the Entrant. Thus, this model provides microfoundations to the concept of predatory pricing and relate it to the empirical finding that it takes time for a seller’s demand to grow.