The Effect of Price Dispersion on Cost of Living Indexes

Abstract

Single good search models imply that mean-preserving increases in the amount of price dispersion reduce expected costs of living of searching consumers. Yet when many goods are consumed, commodity substitution may create a de facto form of fixed sample size search. This leads to the paradoxical result that an increase in price dispersion may reduce nonsearchers' average costs of living more than it does searchers' even--in the fixed sample size search case--if the searchers search only a little. Moreover, mean-and-support-preserving increases in price dispersion may make it optimal to forgo fixed sample size search. Copyright 1994 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.