Information, Uncertainty & Signals
Search Costs: Why the Same Thing Has Different Prices
Why identical products often sell at different prices, how the cost of searching explains it, and what the internet changed.
If markets worked perfectly, identical products would sell for the same price everywhere. Anyone charging more would lose all their customers. Yet in real life, the same brand of headphones, the same medicine or the same bag of rice often sells for different prices in different shops. Economists call this price dispersion.
The cost of searching
In 1961 George Stigler explained price dispersion with search costs. Finding the lowest price takes time, travel and effort. A shopper will keep searching only as long as the expected saving from checking another shop is larger than the cost of doing so.
Because searching is costly, most shoppers stop before finding the absolute cheapest price. Shops know this, so some can charge more and still attract customers. The result is a range of prices for the same product.
Who searches more
Search behaviour depends on what is at stake:
- People search more for expensive items, where savings can be large, than for cheap ones.
- People with more free time, or lower incomes, tend to search more.
- Frequent buyers learn which shops are cheap, so prices for regularly bought goods tend to be less dispersed.
Economists sometimes describe a shopper’s reservation price: the price at which they stop searching and buy.
Driving across town to save 20 percent on a 5 dollar item saves 1 dollar, which is rarely worth the trip. Saving 20 percent on a 1,000 dollar laptop saves 200 dollars, which may well be worth an afternoon's effort. That is why people shop around more for big purchases.
The internet and search
Price comparison websites made searching far cheaper. Studies of goods like books and life insurance found that online comparison reduced prices. But price dispersion did not disappear online. Sellers respond by differentiating themselves with shipping speed, return policies and reputation, and some use complex pricing that makes comparison harder, such as hidden fees added at checkout.
Price differences can reflect service, location, convenience or return policies, not just search costs. A corner shop charging more than a supermarket is partly selling convenience. The key question is whether shoppers could easily compare if they wished.
- Identical products often sell at different prices, a pattern called price dispersion.
- George Stigler explained it with search costs: shoppers stop searching when more search is not worth it.
- People search more for expensive items and when they have more time.
- The internet lowered search costs but did not eliminate price dispersion.
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