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Internet and Price Dispersion June 10, 2007

Posted by jyu in Qualifying.
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3 major results in the literature: 

(1) Internet reduce search costs, increase competition and lower the price

–Bakos (1977): Predicted that the Internet would increase the participation of consumers in markets and create improve matches between buyers and sellers.

–Empirical examples that Internet leads to lower prices and more efficient search for consumers: (a) Brynjolfsson and Smith (2000) and Garbarino (2006): Show that online book and CD prices are below the offline prices of the same items, though the gap seems to have narrowed in recent years. (b) Brown and Goolsbee (2002): Internet lowered term insurance prices by 8-15% from 1995-1997. (c) Zettelmeyer, Scott Morton, and Silva-Risso (2006): Access to price data and referrals through the Internet leads to a decline in transaction prices of about 1.5% and that the benefits of the Internet accure mainly to those who dislike bargaining.

(2) Internet promote brand loyalty and lessen competition and create the potential for seller to increase price

–Lal and Sarvary (1999): Provide one exception that consumer can acquire the known brand over the Internet at a low cost but must incur the cost of traveling to a retailer to get the needed information about the unknow brand.  This gives the seller of the known brand a cost advantage that he/she can exploit in setting prices.

(3) Internet Shopping Agents (ISAs) exhibit a large degree of price dispersion (similar in magnitude to “brick and mortar” retail prices)

–Baye and Morgan (2001) and Iyer and Pazgal (2003) have explained this price dispersion as the adoption of mixed strategies.  Firms want to trade off between extracting surplus from non-searching (loyal) customers and obtaining the business of those who consult with the ISA. 

–Iyer and Pazgal (2003): Because the chance of having the lowest price declines as the number of sellers increases, the authors showed that as long as the reach of the ISA does not increase substantially with the number of members, ISA members will give more weight to loyal customers and charge higher prices as the number of sellers increase, at some point it will be more profitable to cater to exclusively to the non-ISA customers.  Thus, not all sellers will join an ISA.

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