Heterogeneous beliefs, price dispersion, and welfare-improving price controls

Abstract

We consider a search market model where agents have heterogeneous beliefs about the distribution of prices. A suggestive example shows that Jevon's Law of One Price and standard welfare results are not robust to small heterogeneous errors in beliefs. In particular we show that a price ceiling above marginal cost can reduce price dispersion and improve welfare (by lowering aggregate search costs) without decreasing quantity supplied. These results are broadly consistent with the empirical evidence.

Explaining Price Dispersion and Dynamics in Laboratory Bertrand Markets

“…Behavioural models have been developed to bridge the gap between theory and empirical reality. Rauh (2001) shows that price dispersion can arise when sellers make small but heterogeneous mistakes in beliefs about the market price distribution. Baye and Morgan (2004) show that bounded rationality choice models, namely, quantal response equilibrium (QRE) (McKelvey and Palfrey, 1995) and ε-equilibrium (Radner, 1980) can explain price dispersion in homogeneousgood pricing games.…”

Transaction Volume and Price Dispersion in the Presale and Spot Real Estate Markets

“…Theoretical models of price dispersion are largely developed on the information cost regime (Burdett and Judd 1983;Reinganum 1979;Stiglitz 1977, 1985;Diamond 1987Diamond , 1993Rauh 2001). A detailed literature review on price dispersion can be found in Baye et al (2006).…”

Price Dispersion with Directed Search

“…2 The reason is that if a capacity-constrained seller meets more than 1. Examples include the information heterogeneity in Baye, Kovenock, and De Vries (1992) and Varian (1980); the belief-heterogeneity in Rauh (2001); costly search as in Carlson and McAfee (1983) and Daughety (1992); the firm heterogeneity in Reinganum (1979); random search that limits price information as in Burdett and Judd (1983) and Butters (1977), or as in Burdett and Mortensen (1998) and Camera and Corbae (1999); and the predetermined shopping order in Arbatskaya (2007). 2.…”