Consumer Search and Price Dispersion in Supermarkets

Traditional demand models assume that consumers are perfectly informed about product characteristics, including price. However, this assumption may be too strong. Unannounced sales are a common supermarket practice. As we show, retailers frequently change position in the price rankings, thus making it unlikely that consumers are aware of all deals offered in each period. Further empirical evidence on consumer behavior is also consistent with a model with price information frictions. We develop such a model for horizontally differentiated products and structurally estimate the search cost distribution. The results show that in equilibrium, consumers observe a very limited number of prices before making a purchase decision, which implies that imperfect information is indeed important and that local market power is potentially high. We also show that a full information demand model yields severely biased price elasticities.