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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.

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
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    5. Mark Bils, 1989. "Pricing in a Customer Market," The Quarterly Journal of Economics, Oxford University Press, 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.
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    10. Rafael Rob, 1985. "Equilibrium Price Distributions," Review of Economic Studies, Oxford University Press, 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," Review of Economic Studies, Oxford University Press, 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. Abreu, Dilip, 1986. "Extremal equilibria of oligopolistic supergames," Journal of Economic Theory, Elsevier, vol. 39(1), pages 191-225, June.
    16. 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.
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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. repec:eee:indorg:v:55:y:2017:i:c:p:137-165 is not listed on IDEAS
    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.

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