The Noisy Monopolist: Imperfect Information, Price Dispersion and Price Discrimination

Abstract

Although economists often assume that commodities form homogeneous categories with a single price, there are in fact heterogeneities within commodity groupings. Many markets for apparently identical commodities are characterized by dispersion in price and differences in durability and other quality measures. The information a buyer requires in order to obtain the lowest price or best buy must be produced at a cost. For example, various activities for producing this information are reading magazines such as Consumer Reports, consultations with friends and sales personnel, scanning newspaper advertisements and directly sampling store prices. Consumers' search techniques and the efficiency with which they gather information varies. This heterogeneity leads to differences in optimal information-gathering strategies. Those consumers who are more efficient information-gatherers and searchers obtain better buys on average. Although there are clearly private returns to information-gathering, dispersion appears socially wasteful. If there were no dispersion, consumers would not need to engage in this costly learning activity. It is only the failure of the market to price correctly that allows the private returns to search. This waste leads to the suspicion that a monopolistically controlled market will be characterized by a smaller degree of dispersion than a more competitive one. Stigler [19, p. 223] argues that From the manufacturer's viewpoint, uncertainty concerning his price is clearly disadvantageous, the cost of search is a cost of purchase, and consumption will be smaller the greater the dispersion of prices and the greater the optimum amount of search . On the other hand, when consumers differ in their information-generating efficiencies and costs, dispersion serves as a device for splitting up the market to permit price discrimination. The basic idea is as follows. Suppose that demand conditions are such that the monopolist would like to price discriminate against the less efficient informationgatherers; that is, suppose the submarket consisting of inefficient consumers is more price inelastic. Given these potential gains from discrimination, the monopolist must also discover some method of identifying the inefficient, price inelastic consumers. Simply permitting dispersion is such a method since less-efficient information gatherers will search less and thus on average pay a higher price than will efficient searchers. The very presence of dispersion both splits the market and charges a higher purchase price to the submarket of inefficient searchers. Thus, dispersion acts as a costly device for sorting consumers into submarkets to permit price discrimination. If it is not too costly and demand elasticities vary in the correct direction so that the feasible price discrimination is profitable, then dispersion is more profitable than a single price.