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The Effect Of Income Inequality On Price Dispersion

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Abstract

Using a supply/demand consumer model with search, we show under what conditions the distribution of income within a community is related to the type of firms that exist within that community, impacting the level of prices. We assume that searching for the lowest price costs both time and money to the consumer. If time and money costs are high enough low-income consumers cannot afford the monetary cost of search, while wealthy consumer are not willing to take the time to look for the lowest price. The middle class have the right balance of time and money cost of search and therefore are the most aggressive shoppers. We use a supply side model of firm output and pricing strategy to demonstrate that firms located in more informed communities are more likely to enter the market as large low-priced retailers. By connecting these two results, we show under what conditions the size of the middle class can have a negative relationship with the level of prices in a local market. Our paper goes beyond other work on causes of price dispersion by allowing consumers to purchase a continuous amount of the good, and by incorporating a distribution of search costs. Both these modifications allow us to focus more specifically on the link between income distribution and prices.

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Bibliographic Info

Paper provided by University of Haifa, Department of Economics in its series Working Papers with number WP2012/2.

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Length: 41
Date of creation: 06 Aug 2012
Date of revision: 19 Feb 2012
Handle: RePEc:haf:huedwp:wp201202

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  1. Rhodes, Andrew, 2011. "Multiproduct pricing and the Diamond Paradox," MPRA Paper 32511, University Library of Munich, Germany.
  2. Salop, Steven & Stiglitz, Joseph E, 1977. "Bargains and Ripoffs: A Model of Monopolistically Competitive Price Dispersion," Review of Economic Studies, Wiley Blackwell, vol. 44(3), pages 493-510, October.
  3. Braverman, Avishay, 1980. "Consumer Search and Alternative Market Equilibria," Review of Economic Studies, Wiley Blackwell, vol. 47(3), pages 487-502, April.
  4. Frankel, D.M., 1996. "The (Retail) Price of Inequality," Papers 23-96, Tel Aviv.
  5. Diamond, Peter A., 1971. "A model of price adjustment," Journal of Economic Theory, Elsevier, vol. 3(2), pages 156-168, June.
  6. MacDonald, James M. & Nelson, Paul Jr., 1991. "Do the poor still pay more? Food price variations in large metropolitan areas," Journal of Urban Economics, Elsevier, vol. 30(3), pages 344-359, November.
  7. Varian, Hal R, 1980. "A Model of Sales," American Economic Review, American Economic Association, vol. 70(4), pages 651-59, September.
  8. Alcaly, Roger E & Klevorick, Alvin K, 1971. "Food Prices in Relation to Income Levels in New York City," The Journal of Business, University of Chicago Press, vol. 44(4), pages 380-97, October.
  9. Michael Rauh, . "A Model of Temporary Search Market Equilibrium," Economics and Finance Discussion Papers 97-08, Economics and Finance Section, School of Social Sciences, Brunel University.
  10. Rob, Rafael, 1985. "Equilibrium Price Distributions," Review of Economic Studies, Wiley Blackwell, vol. 52(3), pages 487-504, July.
  11. Muller, Christophe, 2002. "Prices and living standards: evidence for Rwanda," Journal of Development Economics, Elsevier, vol. 68(1), pages 187-203, June.
  12. Michael R. Baye & John Morgan & Patrick Scholten, 2006. "Information, Search, and Price Dispersion," Working Papers 2006-11, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  13. Kunreuther, Howard, 1973. "Why the Poor May Pay More for Food: Theoretical and Empirical Evidence," The Journal of Business, University of Chicago Press, vol. 46(3), pages 368-83, July.
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