Imperfect Competition as a Result of Unawareness

This paper develops a dynamic model of price competition where buyers have con- strained consideration sets due to unawareness. There are two sellers: an incumbent, that is initially more well-known among buyers; and an entrant. Awareness is influenced by word-of-mouth: If more buyers choose to shop at a seller, unaware buyers are more likely to discover that seller. In the unique equilibrium, both sellers randomize their pricing strategies, but one seller posts higher expected prices than the other. I show that if the incumbent’s present actions can change the future state of the market to a high enough degree, the incumbent has a strong incentive to undercut the entrant. Thus, this model provides microfoundations for the concept of an “advantage denying” motive and relates it to the empirical finding that time is required for a seller’s demand to grow.