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Market Structure and Price Dispersion

Abstract:This paper presents a new theory of price dispersion based on firm size. We build a model of oligopolistic price competition among n large firms with sequential consumer search, and show that larger firms set higher prices. Since search is random, consumers are more likely to meet sellers from a larger firm. This reduces the consumer's outside option of rejecting a trade with a seller from a larger firm, generating a greater market power for a larger firm. For a given distribution of firm size, there is a unique stationary equilibrium, and price dispersion arises as a pure-strategy equilibrium. Price dispersion disappears as search frictions become vanishingly small, and there is a non-monotonic relationship between the degree of search frictions and the degree of price dispersion. Numerical examples show that price dispersion is welfare reducing and that the Herfinhahl index provides a useful guide for welfare evaluation.