Abstract

Price dispersion, the variance in price for identical products across retailers, is a persistent feature of Internet- based markets, even those mediated by shopping agents (shopbots). In this paper, we propose a model for explaining this price dispersion based on limited consumer awareness of competing retailers and brand sensitivity, the willingness to pay a premium to buy from a leading retailer. We show that full awareness and the absence of brand sensitivity are necessary for markets to be characterized by Bertrand competition. When both of these are not simultaneously true (which is likely for most Internet markets), a number of other pricing strategies become optimal. Branded (high awareness) retailers tend to charge higher prices on average, but in some circumstances will randomize their prices such that they will be lower price than unbranded retailers on some products or some of the time. We also show that even if an unbranded retailer can invest to improve awareness, they have weak incentives to do so as this increases price competition. These observations are consistent with empirical research on pricing in Internet-based markets and may offer a more complete story of Internet price dispersion than some of the leading alternative explanations.

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