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Price Recall, Bertrand Paradox and Price Dispersion With Elastic Demand

Author

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  • Carvalho, M.

    (Tilburg University, Center For Economic Research)

Abstract

This paper studies the consequence of an imprecise recall of the price by the consumers in the Bertrand price competition model for a homogeneous good. It is shown that firms can exploit this weakness and charge prices above the competitive price. This markup increases for rougher recall of the price. If firms have different production costs, those with higher costs are not driven out of the market. However they choose to have a higher price in equilibrium, therefore price dispersion arises. It is shown that firms behave on average as a monopolist with stricter demand and that price dispersion increases with the price recall errors. If bigger recall errors happen, then both consumers and firms on the aggregate level are worse off, for some parameter choices. Furthermore being given the irrational choice that some consumers make, there are situations where the protection of a monopolist against entrants is a welfare maximizing policy. The introduction of more firms in the market does not have a significant impact on the prices. Even though the presented model is static, it can be interpreted as a stage game of an infinitely repeated game where a Nash Equilibrium is played in every stage. The intuition is that consumers do not actually seek information before every purchase, but have a vague idea of the price they faced in previous purchases.

Suggested Citation

  • Carvalho, M., 2009. "Price Recall, Bertrand Paradox and Price Dispersion With Elastic Demand," Discussion Paper 2009-69, Tilburg University, Center for Economic Research.
  • Handle: RePEc:tiu:tiucen:c00b849b-641f-43ed-a493-3a14996448d8
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    File URL: https://pure.uvt.nl/portal/files/1111746/2009-69.pdf
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    References listed on IDEAS

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    1. Alos-Ferrer, Carlos & Ania, Ana B. & Schenk-Hoppe, Klaus Reiner, 2000. "An Evolutionary Model of Bertrand Oligopoly," Games and Economic Behavior, Elsevier, vol. 33(1), pages 1-19, October.
    2. Hehenkamp, Burkhard, 2002. "Sluggish Consumers: An Evolutionary Solution to the Bertrand Paradox," Games and Economic Behavior, Elsevier, vol. 40(1), pages 44-76, July.
    3. Diamond, Peter A., 1971. "A model of price adjustment," Journal of Economic Theory, Elsevier, vol. 3(2), pages 156-168, June.
    4. KalaycI, Kenan & Potters, Jan, 2011. "Buyer confusion and market prices," International Journal of Industrial Organization, Elsevier, vol. 29(1), pages 14-22, January.
    5. Marc Vanhuele & Gilles Laurent & X. Drèze, 2006. "Consumers' Immediate Memory for Prices," Post-Print halshs-00119558, HAL.
    6. David Laibson & Xavier Gabaix, 2004. "Competition and Consumer Confusion," Econometric Society 2004 North American Summer Meetings 663, Econometric Society.
    7. Xavier Gabaix & David Laibson & Hongyi Li, 2005. "Extreme Value Theory and the Effects of Competition on Profits," Levine's Bibliography 784828000000000656, UCLA Department of Economics.
    8. Sendhil Mullainathan, 2002. "A Memory-Based Model of Bounded Rationality," The Quarterly Journal of Economics, Oxford University Press, vol. 117(3), pages 735-774.
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    Citations

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    Cited by:

    1. Levent Kutlu, 2015. "Limited Memory Consumers and Price Dispersion," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 46(4), pages 349-357, June.

    More about this item

    Keywords

    Behavioral Industrial Organization; Bounded Rationality; Price Recall; Price Dispersion; Bertrand Paradox;

    JEL classification:

    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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