DP7319 | Heterogeneous Price Information and the Effect of Competition

Publication Date

07/06/2009

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Abstract

This paper examines how the distribution of prices and consumer welfare change with the number of competitors in a model where consumers di¤er in the amount of price information they have. We only assume that an increase in the number of competitors results in an increase in the probability that consumers observe more prices. We then show, first, that the lower percentiles of the price distribution must decrease when the number of competitors goes up, while the higher percentiles of the price distribution need not decrease. We next provide a sufficient condition for all price percentiles to decline. In such a situation, some percentiles fall more than others, which leads to asymmetric consumer welfare gains from increased competition. Third, we provide a sufficient condition under which the higher percentiles of the distribution of prices paid by all types of consumers increase. When this happens, the probability that a consumer already paying a high price will pay even a higher price increases and it may even be the case that some consumers experience a welfare loss on average. Nevertheless, the weighted average price paid by consumers - the consumer surplus - always (weakly) decreases with increased competition. We provide an empirical strategy to identify how the response of prices to increased competition varies along the price distribution and use gasoline price data from the Netherlands to illustrate.