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The Diamond Paradox: A Dynamic Resolution

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  • 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.

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Paper provided by Northwestern University, Center for Mathematical Studies in Economics and Management Science in its series Discussion Papers with number 1013.

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Date of creation: Nov 1992
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Handle: RePEc:nwu:cmsems:1013

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  1. Stahl, Dale O, II, 1989. "Oligopolistic Pricing with Sequential Consumer Search," American Economic Review, American Economic Association, vol. 79(4), pages 700-712, September.
  2. Fershtman, C. & Fishman, A., 1989. "Price Cycles And Booms Dynamic Search Equilibrium," Papers 8922, Tilburg - Center for Economic Research.
  3. Jennifer F. Reinganum, 1978. "A Simple Model of Equilibrium Price Dispersion," Discussion Papers 335, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  4. Franklin Allen, 1984. "Reputation and Product Quality," RAND Journal of Economics, The RAND Corporation, vol. 15(3), pages 311-327, Autumn.
  5. 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.
  6. Diamond, Peter A., 1971. "A model of price adjustment," Journal of Economic Theory, Elsevier, vol. 3(2), pages 156-168, June.
  7. Benabou, Roland, 1988. "Search, Price Setting and Inflation," Review of Economic Studies, Wiley Blackwell, vol. 55(3), pages 353-76, July.
  8. 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.
  9. Varian, Hal R, 1980. "A Model of Sales," American Economic Review, American Economic Association, vol. 70(4), pages 651-59, September.
  10. 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.
  11. Bils, Mark, 1989. "Pricing in a Customer Market," The Quarterly Journal of Economics, MIT Press, vol. 104(4), pages 699-718, November.
  12. 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.
  13. 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.
  14. 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.
  15. Abreu, Dilip, 1986. "Extremal equilibria of oligopolistic supergames," Journal of Economic Theory, Elsevier, vol. 39(1), pages 191-225, June.
  16. Rob, Rafael, 1985. "Equilibrium Price Distributions," Review of Economic Studies, Wiley Blackwell, vol. 52(3), pages 487-504, July.
  17. Burdett, Kenneth & Judd, Kenneth L, 1983. "Equilibrium Price Dispersion," Econometrica, Econometric Society, vol. 51(4), pages 955-69, July.
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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, FundaciĆ³n 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. 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.

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