Most economics simplify markets and assume that there is one market price. In reality, however, we observe significant price dispersion. Because of this, we see that that searching for the lowest price–while costly–can buyers to superior outcomes. George Stigler (1961) is a seminal paper on the Economics of Information which I will review here.
When should a person search? This occurs when the marginal benefit to search is equal to the marginal cost. Let us assume that the marginal cost of searching is proportional to the individuals cost of time. The marginal benefit of searching is:
The number of searches is denoted as n. We see that people who buy a higher quantity, q, of goods will search longer. One implication of this is that business professional will search more than casual shoppers since they will likely buy higher quantities. Since tourist have little information and purchase low quantities, Stigler accurately predicts that tourist will pay higher prices than experienced buyers.
Also, “the expected savings from search will be greater, the greater the price dispersion of prices.” However, when goods are one-of-a-kind or unique, then the efficiency of searching is extremely low since it is difficult to identify potential sellers.
Brokers can be brought into the market to make it more efficient. These brokers “will eliminate the profitability of quoting very high selling and very low buying prices and will render impossible some of the extreme price bids.” Price dispersion will not disappear entirely when there are brokers since these brokers must make at least some profit to compensate them for their time. As price dispersion nears zero, brokers will leave the market.
What other conclusions does Stigler derive?
- The larger the fraction of the buyer’s expenditures on the commodity, the greater the savings from search and hence the greater the amount of search.
- The larger the fraction of repetitive (experienced) buyers in the market, the greater the effective amount of search (with positive correlation of successive prices).
- The larger the fraction of repetitive sellers, the higher the correlation between successive prices, and…the larger the amount of accumulated search.
- The cost of search will be larger, the larger the geographical size of the market.
- George J. Stigler (1961) “The Economics of Information” Journal of Political Economy, 69(3): 213-225.