IDEAS home Printed from https://ideas.repec.org/p/nwu/cmsems/1013.html
   My bibliography  Save this paper

The Diamond Paradox: A Dynamic Resolution

Author

Listed:
  • Kyle Bagwell
  • Garey Ramey

Abstract

We consider the role of repeat business in resolving the paradox of Diamond (1971). In each period, consumers engage in sequential price search at a positive search cost. Consumers enforce pricing discipline via a simple loyalty-boycott search rule that directs future-period seraches away from firms that raise prices in the current period. In consumers' best equlibria, the equilibrium price decreases continuously with the level of search costs, and the competitive outcome obtains as search costs approach zero. We show further that Rotemberg and Saloner's (1986) finding of countercyclical markups does not arise in the presence of positive search costs.

Suggested Citation

  • Kyle Bagwell & Garey Ramey, 1992. "The Diamond Paradox: A Dynamic Resolution," Discussion Papers 1013, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    • Handle: RePEc:nwu:cmsems:1013
    as

    Download full text from publisher

    File URL: http://www.kellogg.northwestern.edu/research/math/papers/1013.pdf
    File Function: main text
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Ian Domowitz & R. Glenn Hubbard & Bruce C. Petersen, 1986. "Business Cycles and the Relationship Between Concentration and Price-Cost Margins," RAND Journal of Economics, The RAND Corporation, vol. 17(1), pages 1-17, Spring.
    2. Varian, Hal R, 1980. "A Model of Sales," American Economic Review, American Economic Association, vol. 70(4), pages 651-659, September.
    3. John Haltiwanger & Joseph E. Harrington Jr., 1991. "The Impact of Cyclical Demand Movements on Collusive Behavior," RAND Journal of Economics, The RAND Corporation, vol. 22(1), pages 89-106, Spring.
    4. Robert W. Staiger & Frank A. Wolak, 1992. "Collusive Pricing with Capacity Constraints in the Presence of Demand Uncertainty," RAND Journal of Economics, The RAND Corporation, vol. 23(2), pages 203-220, Summer.
    5. Mark Bils, 1989. "Pricing in a Customer Market," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 104(4), pages 699-718.
    6. Fershtman, Chaim & Fishman, Arthur, 1992. "Price Cycles and Booms: Dynamic Search Equilibrium," American Economic Review, American Economic Association, vol. 82(5), pages 1221-1233, December.
    7. Rotemberg, Julio J & Saloner, Garth, 1986. "A Supergame-Theoretic Model of Price Wars during Booms," American Economic Review, American Economic Association, vol. 76(3), pages 390-407, June.
    8. Burdett, Kenneth & Judd, Kenneth L, 1983. "Equilibrium Price Dispersion," Econometrica, Econometric Society, vol. 51(4), pages 955-969, July.
    9. Reinganum, Jennifer F, 1979. "A Simple Model of Equilibrium Price Dispersion," Journal of Political Economy, University of Chicago Press, vol. 87(4), pages 851-858, August.
    10. Rafael Rob, 1985. "Equilibrium Price Distributions," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 52(3), pages 487-504.
    11. Diamond, Peter A., 1971. "A model of price adjustment," Journal of Economic Theory, Elsevier, vol. 3(2), pages 156-168, June.
    12. Roland Benabou, 1988. "Search, Price Setting and Inflation," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 55(3), pages 353-376.
    13. Kyle Bagwell & Michael Peters, 1988. "Dynamic Monopoly Power When Search is Costly," Discussion Papers 772, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    14. Franklin Allen, 1984. "Reputation and Product Quality," RAND Journal of Economics, The RAND Corporation, vol. 15(3), pages 311-327, Autumn.
    15. Olivier Jean Blanchard & Stanley Fischer (ed.), 1991. "NBER Macroeconomics Annual 1991," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262521652, December.
    16. Abreu, Dilip, 1986. "Extremal equilibria of oligopolistic supergames," Journal of Economic Theory, Elsevier, vol. 39(1), pages 191-225, June.
    17. Bernheim, B. Douglas & Peleg, Bezalel & Whinston, Michael D., 1987. "Coalition-Proof Nash Equilibria I. Concepts," Journal of Economic Theory, Elsevier, vol. 42(1), pages 1-12, June.
    18. Stahl, Dale O, II, 1989. "Oligopolistic Pricing with Sequential Consumer Search," American Economic Review, American Economic Association, vol. 79(4), pages 700-712, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Kyle Bagwell & Garey Ramey & Daniel F. Spulber, 1997. "Dynamic Retail Price and Investment Competition," RAND Journal of Economics, The RAND Corporation, vol. 28(2), pages 207-227, Summer.
    2. Douglas D. Davis & Charles A. Holt, 1996. "Markets with posted prices: recent results from the laboratory," Investigaciones Economicas, Fundación SEPI, vol. 20(3), pages 291-320, September.
    3. Mariano Tommasi, 1996. "High inflation: resource misallocations and growth effects," Estudios de Economia, University of Chile, Department of Economics, vol. 23(2 Year 19), pages 157-177, December.
    4. Fishman, Arthur & Hellman, Ziv & Weiss, Avi, 2023. "Habit forming consumers and firm dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 154(C).
    5. Mariano Tommasi, 1993. "Don't be Ignorant: Price Dispersion is Not a Measure of Ignorance in the Market," UCLA Economics Working Papers 699, UCLA Department of Economics.
    6. Fishman, Arthur, 2021. "Finitely repeated search and the diamond paradox," Economics Letters, Elsevier, vol. 205(C).
    7. André de Palma & Patrick Stokkink & Nikolas Geroliminis, 2020. "Influence of Dynamic Congestion on Carpooling Matching," THEMA Working Papers 2020-12, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    8. Sander Heinsalu, 2018. "Competitive pricing despite search costs if lower price signals quality," Papers 1806.00898, arXiv.org.
    9. de Palma, André & Stokkink, Patrick & Geroliminis, Nikolas, 2022. "Influence of dynamic congestion with scheduling preferences on carpooling matching with heterogeneous users," Transportation Research Part B: Methodological, Elsevier, vol. 155(C), pages 479-498.
    10. Obradovits, Martin, 2017. "Search and segregation," International Journal of Industrial Organization, Elsevier, vol. 55(C), pages 137-165.
    11. Somekh, Babak, "undated". "The Effect Of Income Inequality On Price Dispersion," Working Papers WP2012/2, University of Haifa, Department of Economics.
    12. Obradovits, Martin, 2015. "Going to the Discounter: Consumer Search with Local Market Heterogeneities," MPRA Paper 66613, University Library of Munich, Germany.
    13. Sander Heinsalu, 2021. "Competitive pricing despite search costs when lower price signals quality," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 71(1), pages 317-339, February.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Maarten C.W. Janssen & Jose Luis Moraga-Gonzalez & Matthijs R. Wildenbeest, 2004. "Consumer Search and Oligopolistic Pricing: An Empirical Investigation," Tinbergen Institute Discussion Papers 04-071/1, Tinbergen Institute.
    2. Belleflamme,Paul & Peitz,Martin, 2015. "Industrial Organization," Cambridge Books, Cambridge University Press, number 9781107687899, January.
    3. Ralph-C Bayer & Changxia Ke, 2010. "Rockets and Feathers in the Laboratory," School of Economics and Public Policy Working Papers 2010-20, University of Adelaide, School of Economics and Public Policy.
    4. Bruce I. Carlin & Florian Ederer, 2019. "Search Fatigue," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 54(3), pages 485-508, May.
    5. Rauh, Michael T., 2009. "Strategic complementarities and search market equilibrium," Games and Economic Behavior, Elsevier, vol. 66(2), pages 959-978, July.
    6. Alfredo Martín-Oliver & Vicente Salas-Fumás & Jesús Saurina, 2005. "Interest rate dispersion in deposit and loan markets," Working Papers 0506, Banco de España.
    7. Ratul, Lahkar, 2011. "The dynamic instability of dispersed price equilibria," Journal of Economic Theory, Elsevier, vol. 146(5), pages 1796-1827, September.
    8. Maarten Janssen & Paul Pichler & Simon Weidenholzer, 2009. "Sequential Search with Incompletely Informed Consumers: Theory and Evidence from Retail Gasoline Markets," Vienna Economics Papers 0914, University of Vienna, Department of Economics.
    9. Stahl, Dale O., 1996. "Oligopolistic pricing with heterogeneous consumer search," International Journal of Industrial Organization, Elsevier, vol. 14(2), pages 243-268.
    10. ANDERSON, Simon & de PALMA, André, 2003. "Price dispersion," LIDAM Discussion Papers CORE 2003032, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    11. Menzio, Guido & Trachter, Nicholas, 2015. "Equilibrium price dispersion with sequential search," Journal of Economic Theory, Elsevier, vol. 160(C), pages 188-215.
    12. Michael R. Baye & John Morgan, 2001. "Information Gatekeepers on the Internet and the Competitiveness of Homogeneous Product Markets," American Economic Review, American Economic Association, vol. 91(3), pages 454-474, June.
    13. Fishman, Arthur & Simhon, Avi, 2003. "Can Income Equality Increase Competitiveness?," Discussion Papers 14983, Hebrew University of Jerusalem, Department of Agricultural Economics and Management.
    14. Burdett, Ken & Smith, Eric, 2010. "Price distributions and competition," Economics Letters, Elsevier, vol. 106(3), pages 180-183, March.
    15. Greg Kaplan & Guido Menzio & Leena Rudanko & Nicholas Trachter, 2019. "Relative Price Dispersion: Evidence and Theory," American Economic Journal: Microeconomics, American Economic Association, vol. 11(3), pages 68-124, August.
    16. Hämäläinen, Saara, 2018. "Competitive search obfuscation," Journal of Economic Dynamics and Control, Elsevier, vol. 97(C), pages 38-63.
    17. Pedro Dal Bó, 2007. "Tacit collusion under interest rate fluctuations," RAND Journal of Economics, RAND Corporation, vol. 38(2), pages 533-540, June.
    18. Cristina Mazón & Pedro Pereira, 2001. "Electronic commerce, consumer search and reailing cost reduction," Documentos de Trabajo del ICAE 0102, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico.
    19. Bakucs, Lajos Zoltan & Ferto, Imre, 2009. "Milk Retail Sales Patterns in a Transition Economy. The Case of Hungary," 83rd Annual Conference, March 30 - April 1, 2009, Dublin, Ireland 50932, Agricultural Economics Society.
    20. Leung, Charles Ka Yui & Zhang, Jun, 2011. "“Fire Sales” in housing market: is the house-searching process similar to a theme park visit?," MPRA Paper 29127, University Library of Munich, Germany.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:nwu:cmsems:1013. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Fran Walker (email available below). General contact details of provider: https://edirc.repec.org/data/cmnwuus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.