Strategic Pricing, Consumer Search and the Number of Firms

Abstract

discover prices. There are three distinct price-dispersed equilibria characterized by low, moderate and high search intensity. The effects of an increase in the number of firms on search behaviour, expected prices, price dispersion and welfare are sensitive (i) to the equilibrium consumers' search intensity, and (ii) to the status quo number of firms. For instance, when consumers search with low intensity, an increase in the number of firms reduces search, does not affect expected price, leads to greater price dispersion and reduces welfare. In contrast, when consumers search with high intensity, increased competition results in more search and lower prices when the number of competitors in the market is low to begin with, but in less search and higher prices when the number of competitors is large. Duopoly yields identical expected price and price dispersion but higher welfare than an infinite number of firms. A question that has received much attention in economic theory is how the number of competitors and market outcomes are related. Despite the existence of work showing the contrary (see, e.g. Satterthwaite (1979), Rosenthal (1980)), the prediction that emerges from a market where firms interact in a Cournot fashion has come to dominate economic thought, namely, that an increase in the number of competitors leads to larger aggregate production, lower market price and improved market performance measured in terms of some social welfare criterion (Ruffin, 1971). This paper challenges the generality of this belief by presenting an oligopoly model with consumer search where the equilibrium expected price may be constant, increasing or nonmonotonic in the number of firms. We present an economy with two types of consumers: consumers who search for prices at no cost (fully-informed), and consumers who must pay a fixed search cost for each price quotation they observe (less-informed).1 All buyers have the same willingness to pay for the good and buy either a single unit or nothing at all. On the supply side of the market, there are N firms producing a homogeneous good at constant marginal cost. We analyse a one-shot simultaneous move game: firms set prices and consumers decide how many prices to search for at the same moment in time. Our model is essentially an oligopolistic version of Burdett and Judd (1983) where some consumers search costlessly. In this model, consumers search using a fixed-sample-size search strategy, i.e. they choose the number of prices to observe before receiving any offer. Nonsequential search is appealing when consumers find it more advantageous to gather price information quickly (Morgan and Manning, 1985). This occurs when the search outcome is observed with delay and delay is costly. For instance, an MBA graduate looking for a job 1. The presence in the model of consumers who search costlessly captures the fact that some people have a