Lower Search Costs and Variance of Price Distribution

The economic theory attributes search costs as the cause for price disper-sion. Search costs are much lower in electronic markets than in conventional markets, yet various empirical studies have revealed that persistent price dis-persion characterizes online markets. We examine a model of price dispersion, in which buyers face non-negative search costs in a known price distribution, while a distribution of search costs is known to sellers. We show that un-der certain conditions variance of the price distribution can actually increase even though search costs decrease. In addition, the market could display more extreme prices when a decrease of search costs affects the buyers disparately.