Buyer Subsidies in an Equilibrium Model of Price Dispersion

Henrik Orzen and Martin Sefton

German Economic Review, 2003, vol. 4, issue 4, 497-501

Abstract: Abstract. We present a model of equilibrium price dispersion in which a per‐unit subsidy to buyers can reduce average prices. The reason is that subsidies have two effects on average prices that work in opposite directions. First, subsidies raise buyers' willingness‐to‐pay, and by itself this causes firms to charge higher prices. However, since a higher willingness‐to‐pay lowers the relative cost of search, subsidies also induce more search. This creates a second effect that puts pressure on firms to reduce prices. We show that the second effect can dominate, thus causing an overall reduction in average price.

Date: 2003
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https://doi.org/10.1111/j.1465-6485.2003.00091.x

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