Abstract
When consumers do not know the prices at which different firms sell, they often also do not know production costs. Consumer search models which take asymmetric information about production costs into account continue focusing on reservation price equilibria (RPE) and their properties. We argue that RPE assume specific out-of-equilibrium beliefs that are not consistent with the logic of the D1 refinement criterion. Moreover, RPE suffer from a non-existence problem as they typically do not exist when cost uncertainty is large. We characterize an alternative class of socalled non-RPE. We show these equilibria always exist and do not rely on specific out-of-equilibrium beliefs. Non-reservation equilibria are characterized by active consumer search among consumers. As cost uncertainty facilitates search, more consumers make price comparisons resulting in stronger price competition between firms and higher consumer surplus.
Highlights
In consumer search markets, firms have market power due to the fact that some consumers do not make price comparisons
When investigating non-Reservation price equilibria (RPE), we focus on equilibria satisfying the logic of the D1 criterion (Cho and Sobel, 1990)
We have argued that in this environment of cost uncertainty, the standard RPE considered in the consumer search literature suffer from severe limitations
Summary
Firms have market power due to the fact that some consumers do not make price comparisons. Our paper is the first to systematically incorporate Rothschild’s observations on nonreservation price strategies into an equilibrium search model with endogenous firm behavior.2,3 Benabou and Gertner (1993) mention the fact that in their model reservation price equilibria (RPE) may not exist. They set up the equations that have to be satisfied in a non-RPE. This may lead to situations where consumer demand drops significantly if firms price above this reference point, whereas at higher prices, consumers are willing to buy again Such “reference point” demand behavior can occur in non-RPE when the cost uncertainty is large.
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