Imperfect Competition from Unawareness

Imperfect Competition as a Result of Unawareness
Rafael R. Guthmann∗
March 2021
Abstract
This paper develops a dynamic model of price competition where buyers

have constrained consideration sets due to unawareness. Awareness evolves
over time and is influenced by word-of-mouth: if more buyers choose to shop
at one seller, then unaware buyers are more likely to discover that seller. There
are two sellers: an Incumbent, who is initially more well known among buyers,
and an Entrant. In the unique equilibrium, both sellers randomize their pric-
ing strategies, but one seller posts higher expected prices than the other. If
the Incumbent’s present actions change the future equilibrium path to a large
enough degree then it has a strong incentive to undercut the Entrant to reduce
the growth of buyers’ awareness regarding the Entrant. Thus, this model pro-
vides microfoundations to the concept of advantage denying motive and relate
it to the empirical finding that it takes time for a seller’s demand to grow.
Keywords: Price competition, discovery, equilibrium price dispersion

JEL codes: D43, D83
This research did not receive any specific grant from funding agencies in the public,
commercial, or not-for-profit sectors.
∗
Department of Economics, Pontifı́cia Universidade Católica do Rio de Janeiro (PUC-
Rio), Rua Marquês de São Vicente, 225-Gávea, Rio de Janeiro, RJ, 22453-900, Brasil.
Email: rafael.guthmann@econ.puc-rio.br. This paper is based on a chapter of my PhD
dissertation, which began at the University of Minnesota in Spring 2015. I am grateful to
Guido Menzio, David Rahman, Varadarajan V. Chari, Erzo G. J. Luttmer, Jan Werner,
Aldo Rustichini, Chris Phelan, Timo Hiller, Yvan Bécard, the participants of the economic
theory workshops at Minnesota, and the Spring 2018 Midwest Economics Association Meet-
ings for their helpful conversations and feedback.
Electronic copy available at: https://ssrn.com/abstract=3710809

1 Introduction
Product markets for identical goods feature many deviations from the textbook model
of the competitive market. Among the most notable of these deviations is that, in-
stead of the law of one price, there is substantial price dispersion1 , different sellers
(who compete by offering identical goods) appear to face different seller-specific de-
mands and also, these seller-specific demand functions appear to grow over time2 ,
thus, observed transaction prices depend on a seller’s tenure in the market.3 In ad-
dition, there is a common conception that the behavior of sellers in a given industry
depends on the prospects of future competition.4
This paper presents a simple model of dynamic competition based on the diffusion of
awareness of the buyers regarding the sellers present in the market. This model can
explain these “empirical anomalies” from the model of the competitive market, but
it also nests the competitive model as its frictionless limit (defined as the situation
where the buyers’ awareness instantly incorporates the entry of sellers). I examine
a situation where finitely many sellers compete for the demand of a large number
of buyers. The buyers’ consideration sets regarding the sellers they can purchase
the good from can be incomplete and their consideration sets evolve over time in a
manner that appears exogenous to them (the buyers). The evolution of the buyers’
consideration sets depends on the past choices made by the other buyers: diffusion
of awareness among buyers occurs through word-of-mouth, which is represented by
a probability of discovery that depends on the population of buyers who shop at the
seller at that period. The rate buyers forget the seller is exogenously given. Because
these processes of discovery and forgetfulness are both beyond the control of the
buyers, their constrained choice sets can be interpreted as being due to unawareness
and not because of a conscious choice by the buyers to not search for all sellers present
in the market.
A seller’s customer base is defined as the population of buyers aware of that seller.
When formulating their price posting strategy, the seller considers the effects of their
1
See, e.g., Sorensen [33], Kaplan and Menzio [25], and Kaplan and Menzio and Kaplan, Menzio,
Rudanko, and Trachter [19], the last two assessed the standard deviation of prices for transactions
at around 15% in markets for non-durable consumption goods.
2
Foster, Haltiwanger, and Syverson [13].
3
Foster, Haltiwanger, and Syverson [12],[13]
4
For example, Besanko et al. [3, 4].

strategy on future customer base accumulation, along with the present effect on sales.
When a seller considers posting a lower price, this will imply higher sales in the present
and, therefore a higher degree of diffusion of awareness about the seller among the
buyers and a larger number of potential customers in the future. However, an increase
in the seller’s customer base in the future will have ambivalent consequences for the
expected profits of the seller in future periods: if the seller has a large market share
its strategy impacts the future profitability of its competitors as well. Thus, model
studied here is relevant in industries where there substantial portion of the market is
served by few firms and therefore these firms’ strategies have relevant consequences
for the entire industry.
This paper studies dynamic competition between two sellers in a two period model.5
In period 1, the sellers take into consideration the dynamic effect of their competition
regarding buyers’ consideration sets in period 2: if a seller attracts more customers
in period 1 than in period 2, the seller becomes more well-known among the buyers,
which provides a dynamic incentive on their pricing strategies regarding their effect
on a seller’s demand and the susceptibility that the other seller might have on future
demand. If the competitor is not undercut, then awareness regarding it grows faster,
which has an important effect on future strategic interaction.
Equilibrium is unique and it features randomized pricing strategies. If buyers can
very easily discover the sellers, then the equilibrium approximates perfect compe-
tition, but this dynamic awareness model produces a rich set of possible outcomes
if awareness frictions are substantial. The model can explain why firms post lower
prices when they are smaller and predict that under certain conditions, sellers might
price lower than the marginal cost. However, under certain conditions, the model
also predicts that “predatory pricing” (a situation where the Incumbent posts very
low prices in the present to reduce the intensity of competition from the Entrant in
the future) can occur in equilibrium as well. Randomized pricing strategies always
occur in equilibrium (except at the competitive limit case, when the distributions of
prices converge to the point equal to the marginal cost), which is consistent with the
empirical findings that prices tend to be dispersed even in product markets where
there are identical goods.
The following subsection provides a short description of the related literature. Section
5
Subsection 5.2.2 of the Appendix shows how to solve for the equilibrium of the model with
N > 2 sellers.

2 provides a description of the environment and Section 3 describes the equilibrium
of the model and its properties. Section 4 offers some concluding remarks. In the
Appendix in Section 5.2 presents extensions of the model. Subsection 5.2.1 shows
how the results of the paper apply to a more general formation of the buyer’s demand
besides unit demand. Subsection 5.2.2 describes how to characterize the equilibrium
with N > 2 sellers.
1.1 Related literature

A major motivation for developing a model that combines price dispersion and
customer-capital is that the empirical evidence suggests that individual sellers have
specific demand and that this demand is accumulated over time. Empirical studies
such as the one by Foster, Haltiwanger, and Syverson [12] show that in product mar-
kets for homogeneous goods, incumbent plants sell their output for higher prices than
entering plants. Foster, Haltiwanger, and Syverson [13] also find robust evidence that
incumbent plants have higher plant-specific demand than competitors who entered
more recently.
The papers of Butters [7], Varian [35], and Burdett and Judd [6] are seminal contri-
butions for the study of equilibrium price dispersion for an physically identical good.
Ireland [18], McAfee [23],[24] present models that are closely related to this paper,
the first two papers feature competition where buyers have imperfect access to the
sellers. Further, Armstrong and Vickers [1] study an environment where accessibility
regarding different sellers is not independent which implies that richer behavior in
randomized pricing strategies can occur.
The contribution of the present study over existing models of equilibrium price disper-
sion is that it extends the model to an environment where sellers’ strategies influence
the evolution of the buyer’s consideration sets, and this is taken into consideration
by the agents in equilibrium. These dynamics bear some similarities to Klemperer’s
[22] model of switching costs and provide microfoundations for example, to Chen
and Rosenthal [8] model of changing customer loyalties, and Szech’s [34] model of
behavioral customers.
Besanko, Doraszelski, and Kryukov [3] define predatory pricing by the distinction
between aggressive pricing due to the advantage-building motive, where, by pricing
aggressively, a firm may improve its competitive position in the future from the

advantage-denying motive, where the firm prevents its rival from becoming a more
formidable competitor by undercutting it. The second motive can be called predatory
pricing even if the number of firms active in a market is exogenously fixed, in contrast
to predatory pricing being only an instrument deter entry of potential competitors
(such as Milgrom and Roberts [26]). Both of the advantage-building motive and the
advantage-denying motive are endogenously generated by the model in the present
paper.
Several previous studies also feature information dissemination when it comes to the
buyer side of the market. Dinlersoz and Yorukoglu [10] feature a model where buyers
have constrained consideration sets, but in their model, the evolution of buyers’
consideration sets is driven by investment in advertisement by sellers, while in the
current study it is driven by the past sales activity of the seller. Gourio and Rudanko
[15], use directed search (“queues”) to analyze customer-capital accumulation. Pozzi,
Paciello, and Trachter [28] and Gilbukh and Roldan [14] use random search models. A
major discrepancy between the current study and these previously mentioned models
is that the customer accumulation mechanism used in the present study consists of
word-of-mouth contagion and that at a given period, buyers can choose to shop at
any seller present in their consideration set. The model presented in the current
study also has similarities to Fishman and Rob’s [11] model of reputation acquired
through word-of-mouth.6
The use of the expression unawareness is based on the literature on unawareness in
decision theory. In economic theory, unawareness is a distinct concept from uncer-
tainty: Uncertainty is described as a situation where the decision maker does not
know in which state of the world they might be in, but they have a complete and
exhaustive description of the possible states of the world; unawareness describes the
ignorance regarding the description of the world in which the decision maker op-
erates. To see why standard state space models preclude unawareness, see Dekel,
Lipman, and Rustichini [9] and Schipper [31]; examples of general decision theoretic
formulation of unawareness include Modica and Rustichini [27] and Heifetz, Meyer,
and Schipper [17]. More recently, Karni and Viero [21][20] extend Savage’s [30] model
6
In both cases, from the perspective of the buyers, their information is independently determined
from their individual choices but instead is produced through contact with customers of the seller.
In contrast, this study considers awareness diffusion among buyers regarding the sellers operating
in the industry, who sell perfect substitutes, instead in Fishman and Rob’s model word-of-mouth
transmits information regarding the quality of the product sold by different sellers.

of uncertainty to the discovery of opportunities that decision makers were previously
unaware of.
For the purposes of the current paper, unawareness can be simply described as incom-
plete consideration sets of the buyers regarding the sellers operating in the market.
Its dynamic evolution is described as the addition or subtraction of sellers from their
consideration sets. Because the buyers are unaware of sellers that they might dis-
cover in the future, this process is exogenous from the point of the view of the buyers
(because they are unaware of the seller, this means that they cannot anticipate their
own discovery of that seller in the future). Evolving awareness has been previously
used in the study of imperfect competition in Perla [29].
2 Environment
This section presents a description of the environment used in the remainder of the
paper.
2.1 Physical environment

Consider a market for a single perishable, indivisible good. There are two periods
indexed by t = 1, 2. There is a continuum of identical buyers of unit measure. Each
buyer has a unit demand for the good in each period and reservation price equal to
one. There are two sellers in this economy, which I call I and E (which stand for
“Incumbent” and “Entrant”, respectively). The sellers can produce the indivisible
good at a constant marginal cost normalized to zero.
Buyers may be aware of zero, one, or both sellers. Let Ait ⊂ {I, E} be the consid-
eration set of buyer i that represents the set of sellers that i is aware of in period
t, and let mjt ∈ [0, 1] represent the fraction or the measure of the buyers aware of a
seller j in period t. I call mjt the customer base of j, a seller is said to be larger
than the competitor if their customer base is larger.7 Let mt = (mIt , mE
t ) be the pair
of customer bases of each seller in period t ∈ {1, 2}. It is assumed that in period 1,
the Incumbent seller I has a more consolidated position than the Entrant E, so its
customer base is larger: mI1 > mE 1.
The term mjt refers to what McAfee [23] calls availability to the seller and Ireland [18] calls
7
provision of information.

Buyers
{i : I ∈ Ait } {i : E ∈ Ait }
Figure 1: Venn diagram of the set of buyers categorized by consideration sets.
2.2 Discovery and memory loss

From period 1 to period 2 the buyers can discover or forget the sellers. A buyer i
who is unaware of a seller j in period 1 can discover j by the period 1 by meeting
other buyers who are customers of that seller. To construct a matching process that
articulates this concept consider the interval [0, 1] that represents the population of
buyers who can become aware of seller j. As buyers have unit demand for the good,
the quantity qtj sold by the seller in period t is the same as the population of buyers
who decide to purchase from j. The population who is not aware of the seller is a set
of buyers of measure 1 − mjt . Consider a matching process where buyers who do not
know j randomly meet customers of j who just purchased from j and then become
aware of j through word of mouth (as in Fishman and Rob [11]). Suppose that the
probability that a buyer i who is not aware of j meets a customer of j is a strictly
increasing and concave function D(qtj ) ∈ [0, 1] of the number of customers of j. The
function D is non-decreasing to represent the increase in awareness diffusion through
an increase in word-of-mouth activity among the buyers regarding sellers who have
more customers.
Then, the measure of buyers in [mj1 , 1] who become aware of j from period 1 to 2 is
described by a logistical matching function µ that satisfies
µ(D(q1j ), 1 − mj1 ) = (1 − mj1 )D(q1j ).

Note that µ is concave and strictly increasing on both arguments, and D satisfies
D(q1j ) < 1 for all q ∈ [0, 1). Let Φ be Φ(q1j , 1 − cj1 ) = µ(D(q1j ), 1 − cj1 ). A buyer i who
is aware of a seller j in period t forgets about j with a probability δ ∈ [0, 1) by the
next period. Thus, the customer base of a seller j behaves like a stock, and it evolves
according to
mj2 = (1 − δ)mj1 + µ(D(q1j ), 1 − mj1 ). (1)
Discovery and memory loss are assumed to be independent, which implies that the
buyer’s awareness of the sellers is independent. That is, the probability that an
arbitrary buyer i is aware of a seller j ∈ {I, E} in period t is mjt , whether i is aware
of the competing seller h 6= j or not. See Appendix 1 for a detailed analysis regarding
dynamic independence of awareness.
2.3 Strategies and payoffs

Buyers shop at the lowest-priced seller in their consideration sets. Sellers are strategic
and at each period t ∈ {1, 2} they choose a price p ∈ (−∞, 1] to announce to the
buyers, where a price of 1 means that the seller makes an offer that captures the
whole surplus from the transaction.8 Sellers can play a mixed strategy of posting
prices, described by a c.d.f. Ftj for seller j ∈ {I, E} in period t ∈ {1, 2}.
Given a customer base profile mt = (mIt , mE h
t ) and that Ft is the distribution of
prices posted by the competitor seller h 6= j, the probability that a seller j sells the
good to a buyer in their customer base at a price p is S(p, Fth , mt ), which satisfies
the expression
S(p, Fth , mt ) = (1 − mht ) + mht [1 − Fth (p)] (2)

= 1 − mht Fth (p)
where the term (1−mht ) is the probability that the buyer is unaware of h, so the buyer
purchases from j for any price p ∈ (−∞, 1]; here mht [1 − Fth (p)] is the probability the
buyer is aware of h, and p is lower than the price posted by h (which occurs with
probability 1 − Fth (p), which is independent of the probability that buyer is aware of
h). In the case Fth has a point p∗ with strictly positive probability mass, then there
8
Sellers can offer prices below 0, which means that they can offer the good for below its marginal
cost, which can occur in equilibrium.

is a possibility of a tie in prices at p = p∗ , and if a tie occurs there is a sharing rule
that favors one seller over the other, this is described in the next section as a part of
the construction of the equilibrium (as in Simon and Zame [32]).
Given a realized pair of prices (pIt , pE I E
t ) and a customer base profile (mt , mt ), the
quantity sold by seller j ∈ {I, E} can be either q jt = mjt or q jt = mjt (1 − mht ), in the
case seller j undercuts the competitor or is undercut by the competitor, as all buyers
who are aware of the lowest-priced seller shop there (or, in the case that there is a
tie in prices and j is favored or not according to the sharing rule). Customer bases
evolve according to the volume of sales; therefore, if one seller undercuts the other
seller, their customer base is larger in the next period. Let (mj2 , mh2 ) be the pair of
customer bases in period 2 if j undercuts h given a customer base profile (mI1 , mE 1 ),
j h
and (m2 , m2 ) is the pair of customer bases if h undercuts j, which are given by 1
with quantities sold q j1 and q j1 , respectively.
The profits a seller j makes in a period t are the sales probability multiplied by the
size of j’s customer base and the posted price:
π(p, Fth , mt ) = mjt pS(p, Fth , mt ), (3)
and the sellers discount future profits according to a discount factor β ∈ (0, 1).
3 Equilibrium
This section describes the definition of equilibrium and characterizes it. The solution
concept used here is subgame perfect equilibrium: for each period t ∈ {1, 2}, equi-
librium is consistent with the maximization of the present value of a seller’s profits.
Thus, a seller’s present discounted payoffs includes expected future profits, thus in
period 1 the equilibrium value of a seller j payoff is
π(p, F1h , m1 ) + βE[π(p, F2h , m2 ) | p, F1h , m1 ],
where p is a price on the support of j’s equilibrium price distribution in period t

and E[π(p, F2h , m2 ) | (p, F1h , m1 )] is the expected profits in period 2 conditioned on
(p, F1h , m1 ).
Definition 1. An equilibrium consists of pricing strategies for each seller and a

sharing rule such that for each subgame starting in period t ∈ {1, 2}, the present
value of profits (payoffs) is maximized.
3.1 Characterization of the unique subgame perfect equilib-

rium
Before stating the main result, I introduce some notation: For seller j ∈ {I, E} and
h 6= j let v2 (mj2 , mh2 ) be the equilibrium profit level of j in period 2 given the profile
of customer bases (mj2 , mh2 ). Let ∆j (m1 ) satisfy

β
j
v2 (mj2 , mh2 ) − v2 (mj2 , mh2 ) ,

∆ (m1 ) = (4)
mj1
∆j is a term that represents the gain in future payoffs if seller j undercuts the rival
seller, which is normalized by the relative size of their customer bases. Let pj1 be
given by
pj1 = (1 − mh1 ) − ∆j (m1 ). (5)
Proposition 1. Equilibrium is unique and features non-generate distributions of

prices {Ftj }j∈{E,I},t∈{1,2} along a sharing rule. The sharing rule implies all buyers
give preference to the smallest seller in period 2 and to the seller j ∈ {I, E} with the
smallest term pj1 in period 1. That is, in both periods, the sharing rule gives preference
to the seller that is more willing to undercut the other.
The distribution of prices satisfy:
1) In period 1, for each seller j ∈ {I, E}, F1j has support [p1 , 1], where p1 = max{pI1 , pE
1
}
j
and for each p ∈ [p1 , 1],F1 (p) is given by
p − p1
F1j (p) = , (6)
mj1 [p + ∆h (m1 )]
2) In period 2, for each seller j ∈ {I, E}, F1j has support [p2 , 1], where p2 = max{1 −
mI2 , 1 − mE
2 } and for each p ∈ [p2 , 1],
p − p2
F2j (p) = . (7)
mj2 p
10

Proof. Solve for the unique subgame perfect equilibrium by backward induction from
period 2 to period 1.
Period 2. The static game in period 2 has been studied by Ireland [18], McAfee
[23], and Szech [34], the equilibrium is unique, for a detailed proof see the appendix
subsection 5.2.2. It consists of a pair of cumulative distribution functions (F2I , F2E )
that shares a common support [p2 , 1], where
p2 = max{1 − mI2 , 1 − mE
2 }. (8)
For each p in (p2 , 1), and for seller j ∈ {I, E}, the distribution F2j (p) satisfies
p − p2
F2j (p) = , j ∈ {I, E}.
mj2 p
Period 1. For any pair of customer bases in period 2, there is a unique equilibrium;
thus, a pair of unique values v2j (mj2 , mh2 ) = p2 mj2 for each seller j ∈ {I, E} both when
the seller undercuts or is undercut by the competitor. Consider the candidate for the
unique equilibrium in the subgame beginning in the first period that features a pair
of distributions {F1E , F1I } posted by E and I, respectively. They share a common
support [p1 , 1], where p1 = max{pE , pI }, for pj1 , j ∈ {I, E} described by 5. Each
distribution F1j satisfies the following
p − p1
F1j (p) = . (9)
mj1 [p + ∆h (m1 )]
For p ∈ [p1 , 1) and for j ∈ {E, I}, ∆h (m1 ) is described by 4. To see why this is an
equilibrium, note that the equal profit condition in period 1 for prices in the interior
of the support [p1 , 1] is as follows:
p1 mj1 + βv2j (mj2 , mh2 )

n o
= pmi1 [1 − F1h (p)mh1 ] + β [1 − mh1 F1h (p)]v2j (mj2 , mh2 ) + mh1 F1h (p)v2j (mj2 , mh2 ) .
11

Solving the equal profit condition above for F1h yields
p − p1
F1h (p) = hh i (10)
m
mh1 × p + β m1j v2 (mj2 , mh2 ) − v2 (mj2 , mh2 )
1
p − p1
= . (11)
mh1 [p + ∆j (m1 )]
Let j be the seller such that pj = max{pE , pI } if pE 6= pI . Then note that 9 implies
lim F1j (p) < 1.

p↑1
Therefore, the distribution F1j has an atom at 1. Thus, a tie occurs with a positive
probability if the seller j’s competitor, h, considers posting a price of 1. However, h
is indifferent between posting 1 and prices in the interior of the support because the
tie breaking rule implies that h sells the good with a probability of one in case of a
tie with j.
It is easy to see that the present value from posting a price below p1 will be lower
than posting p1 , and the strategies (F1E , F1I ) make I and E indifferent between posting
prices on the support. Therefore, equation 9 describes a pair of price distributions
for the first period that are consistent with equilibrium.
It remains to shown that (F1E , F1I ) is the only distribution of prices consistent with
equilibrium. The indifference conditions over the support imply that if [p1 , 1] is the
support of equilibrium strategies then (F1E , F1I ) are the only distributions that make
E and I indifferent among the prices posted in the support given the tie-breaking
rule.
Need to show that [p1 , 1] is the only support consistent with equilibrium. By the same
arguments as in Varian [35] the equilibrium features distributions with a common
connected support. Note that for any upper bound that is lower than 1, it is easy
to see a seller would strictly prefer to post 1 over that lower bound. Although for a
lower bound p < p1 , it would be impossible to maintain the equal profit condition
with posting 1 for both sellers. For a lower bound p > p1 , it would imply that given
the tie-breaking rule, for one of the sellers, it will not be possible to maintain the
equal profit condition between p and 1 for any distribution of prices with support
[p, 1]. This is the case because posting the monopoly price 1 would strictly dominate
posting p for at least one of the sellers. Thus, the equilibrium is unique.
12

3.2 Implications of the Model
The static equilibrium at period 2 as described in Proposition 1 is a generalized
finite-seller case of Butter’s [7] model of price dispersion in which buyers have a
different probability of incorporating different sellers in their consideration sets. This
equilibrium at period 2 has the property that the price distribution of larger sellers
first-order stochastically dominates those of smaller sellers. This property has already
been found in Ireland [18] and McAfee [23]. The reason is that the probability that
the customers of the smaller seller are aware of the larger seller is higher than the
probability that customers of the larger seller are aware of the smaller seller. Thus,
if a small seller raises prices, it is more likely that the seller loses customers to the
larger seller than if the larger seller raises prices. Therefore, the smaller seller has
more incentives to undercut.
The innovation of the current paper is that it extends the concept of constrained con-
sideration sets to a dynamic model where the evolution of the buyers’ consideration
sets depends on the strategies of the sellers. These novel assumptions have certain
implications regarding the prices practiced in equilibrium. Note that a key assump-
tion behind the new results is the assumption that word-of-mouth depends on the
active purchasing behavior of customers. If we suppose instead that word-of-mouth
spreads among buyers irrespective if the buyers purchased the good or not then sell-
ers strategies would not have dynamic consequences and the equilibrium described
in period 2 would also apply to period 1.
Given the assumption that the memory depreciation rate δ is not too high relative
to the probability of discovery of the Incumbent in the first period, D(ms ), then
the Incumbent grows by the second period and has a larger customer base than the
Entrant: mI1 > ms = mE 1 . According to the static equilibrium of period 2, the
seller with the largest customer base posts the highest prices, because the demand
for the larger seller is less elastic in equilibrium than for the smaller seller. However,
Proposition 1 implies that in the dynamic equilibrium of period 1, the dynamic
gains from increasing the customer base might dominate the static effect, and the
Incumbent seller I with a larger customer base might post higher prices than the
Entrant seller E, who has with the objective of preventing the growth of the Entrant in
the future. This notion is similar to what is described in the literature as a “predatory
pricing” policy or advantage-denying motive by the Incumbent (see Bolton et al. [5]
13

and Besanko et al. [3]).
The condition for behavior being dominated by the advantage-denying motive is
formally presented in the following corollary:
Corollary 1. If the dynamic gain in payoffs (given by equation 4) satisfies
∆I − ∆E > mI1 − mE
1, (12)
then the distribution of prices posted by the Incumbent seller is first order stochasti-
cally dominated by the distribution of prices posted by the Entrant.
The intuition behind this result is that when an Incumbent seller is large relative to
the market, then its pricing strategy has a great influence in the growth of awareness
regarding the Entrant, so the Incumbent has an incentive to undercut the Entrant to
prevent the buyers from discovering him or her. On the other hand, if the Incumbent’s
strategy has little influence on the growth of awareness regarding the Entrant, then
the Incumbent will post higher expected prices to take advantage of the reduced
elasticity of demand due to their larger customer base, as it grew over period 0 to
period 1. In this manner, this model can replicate both the stylized fact that older
firms sell at higher prices in markets where each firm has a small market share (Foster
et al. [12, 13]), but it can also provide conditions for the existence of predatory-like
pricing behavior by firms with large market share.
There is the knife’s edge case where both the Incumbent and Entrant post prices
according to the same distribution, which only occurs if the variation in their dynamic
gains that come from undercutting the competitor are identical to the difference in
their present sizes:
Corollary 2. If ∆I − ∆E = mI1 − mE 1 then both sellers post prices according to

the same distribution in period 1 (in this case, any sharing rule is consistent with
equilibrium as the probability of a tie in prices for any price on the support is 0).
Prices lower than the marginal cost also occur in equilibrium if the gains from posting
lower prices in terms of future profits are large enough:
Corollary 3. If ∆j (m1 ) > (1 − mh1 ), ∀j ∈ {I, E}, then there is a positive probability
that posted prices are below the marginal cost.
14

Cumulative Probability
F1I
F1E
0 Price
p = 0.425 p = 1.0
Figure 2: The equilibrium price distributions in period 1 featuring ”predatory pric-

ing”: the Incumbent posts much lower prices on average than the Entrant, to keep the
Entrant from growing. The functional form is D(x, y) = min{1, (x/y)2/3 }, parameter
values δ = .05, β = .95, ms = .35.
Finally, note that the equilibrium cumulative distribution of prices at some period t
converges to the marginal costs if unawareness vanishes:
Corollary 4. If 1 − mjt → 0, ∀j, t ≥ 1 then for any j in period t and for any price
p > 0 then Ftj (p) → 1.
In this case, buyers have both sellers in their consideration sets in all periods where
the two sellers are active in the market. Therefore, we have a case of Bertrand
competition, so prices are equal to the marginal cost, and the gains from the future
grow in the customer base are null: because the customer base is size 1, no buyers
can discover the seller (as shown by the law of motion 1) thus there are not incentives
for sellers to cut down prices as an investment; thus, ∆j (m1 ) → 0 if m1 → (1, 1).
Then, in period t = 1, because the profits are zero in the next period, the subgame
in period 1 is analogous and so we also have perfect competition.
Because utility is transferable in this economy, the set of core allocations is well de-
fined: the only core allocation among all agents in this environment is the competitive
allocation (where all surplus is appropriated by the buyers). The reason for this is
because any allocation where any seller receives a positive surplus can be blocked by
another allocation that can be implemented by the coalition of buyers along with the
15

competing seller. That is so because each of the seller’s marginal product is zero.
Thus, when unawareness vanishes, it is reasonable to expect that any allocation not
in the core would be blocked, and this game represents one of the simplest conceiv-
able but non-trivial environments such that the set of competitive allocations are the
same as the core.
4 Concluding Remarks
The current paper examined a dynamic price competition game where the consid-
eration sets of buyers evolve over time. In this model, a buyer’s consideration set
represents the buyer’s awareness regarding the sellers present in the market. Thus, a
buyer can discover additional sellers and forget the sellers that were in their consid-
eration set. In this study, the equilibrium price distributions depends on the length
of time that the seller has been operating in the market. As a result, the model can
generate richer equilibrium behavior than other models of equilibrium price disper-
sion.
Typically, one would expect the Incumbent seller who has built up a larger customer
base, to post a higher expected price than the Entrant, but under certain conditions
the Incumbent can price lower to reduce the growth of the Entrant’s customer base.
This predatory behavior occurs in equilibrium not with the intention of driving out
the competitor from the market (understood to not be a credible strategy according to
the “The Chicago School view” according to Baker [2]) but to keep more customers
captive in the future. Alternatively, this model also provides another theoretical
explanation of why firms might price below cost in the present: to increase the
growth rate of awareness regarding the firm among buyers in the market.
This paper (as the closely related extension of the model in Guthmann [16]) also
provides an example of how dynamic factors do matter for the determination of the
frictions of trade present in the market and influence the strategies of the players. The
study of the intersection between the study of frictions of trading and the study of
the dynamics of information diffusion might have many other applications in diverse
areas of economics.
16

5 Appendix
5.1 Independence of Awareness

Formally, the probability that i discovers j in period t conditional on i being aware
of h 6= j is the same as the unconditional probability: Pr(j ∈ Ait+1 \ Ait : h ∈ Ait ) =
Pr(j ∈ Ait+1 \ Ait ). The loss of memory is independent, meaning that the probability
an arbitrary buyer i forgets seller j is the same whether i was aware or not of seller
h, h 6= j: Pr(j ∈ Ait+1 \ Ait : h ∈ Ait ) = Pr(j ∈ Ait+1 \ Ait ). In period 0, awareness
is assumed to be independent. Then, as stated in Lemma 1 below, awareness is
independent for any period t. That is, the probability of buyer i being aware of
seller j is αjt conditional on buyer i being aware or not of another seller h; thus,
Pr(j ∈ Ait : h ∈ Ait ) = Pr(j ∈ Ait ) = αjt .
Lemma 1. If discovery and memory loss are independent, and awareness is inde-
pendent in period 0, then at any period t > 0, awareness is independent. That is, for
any period t, the probability that buyer i who is aware of some seller j is also aware
of another seller h is αth ; that is, P (h ∈ Ait : j ∈ Ait ) = P (h ∈ Ait ) = αth .
Proof. To see that the assumption of independence of discovery implies that the
evolution of {αj }t does not affect the independence of awareness consider the following
case: Suppose that independence of awareness holds for some period t: Buyers who
were aware of seller I are aware of seller E with probability αt2 ∈ (0, 1), so the
probability buyers are aware of E conditional on being aware or unaware of I is
the same: Pr(E ∈ Ait : I ∈ Ait ) = Pr(E ∈ Ai : I ∈ / Ait ), and both are equal to
Pr(E ∈ Ait ) = αt2 . Also, suppose that δ > 0 and D(n) ∈ (0, 1) for n ∈ [0, 1). Which
means that, from period t to period t + 1, a positive measure of buyers who were
aware of seller E forget E and also that a positive measure discovers seller E.
Consider the partition the buyers into the following subsets in period t + 1:
I
Rt+1 = {i : I ∈ Ait ∩ Ait+1 }
I
Ft+1 = {i : I ∈ Ait ∩ (Ait+1 )c }
I
Ut+1 = {i : I ∈ (Ait )c ∩ (Ait+1 )c }
I
Dt+1 = {i : I ∈ (Ait )c ∩ Ait+1 }.
17

I
In words, Rt+1 is the subset of buyers who were aware of seller I in period t and still
I
remember I in period t + 1 (that is, I remains in their consideration sets), Ft+1 is the
subset of buyers who were aware of seller I in period t and forgot about I in period
I
t + 1, Ut+1 is the subset of buyers who were unaware of seller 1 in period t and are
I
still unaware in period t + 1, and Dt+1 is the subset of buyers who were unaware of
seller I in period t and discover seller 1 by period t + 1.
As Pr(E ∈ Ai : I ∈ Ait ) = Pr(2 ∈ Ai : 1 ∈
/ Ait ), and by the assumption that discovery
and memory loss are independent, the fractions of buyers in each of these four subsets
who discover E or forget E are the same. Thus, Pr(E ∈ Ait+1 : i ∈ Rt+1 I
) = Pr(E ∈
i I i I i I
At+1 : i ∈ Ft+1 ) = Pr(E ∈ At+1 : i ∈ Ut+1 ) = Pr(E ∈ At+1 : i ∈ Dt+1 ) = Pr(E ∈
Ait+1 ). Therefore,
Pr(E ∈ Ait+1 : I ∈ Ait+1 ) = Pr(E ∈ Ai : I ∈

/ Ait+1 )
= Pr(E ∈ Ait+1 )
2
= αt+1 .
Therefore, independence holds for the period t + 1. Independence is assumed to hold

in period 0 so, by induction, it holds for all periods.
5.2 Extensions
5.2.1 General consumer demand
In the main body of the paper it is assumed that buyers have unit demand with
valuation normalized to 1. Here, it is shown how the paper’s results apply to more
general demand functions. Suppose that the demand function for the good by a
measure a of buyers is described by a function aD(p), where D : R → R+ is a
strictly decreasing continuous function and sellers have marginal cost c ∈ R+ , as
there is a unit measure of buyers the total demand is described by D(p). Let ΠM be
the monopoly profits that can be obtained by a sellers choosing to post a single price
pM to a unit measure of buyers:
ΠM = max(p − c)D(p)
p∈R
= (pM − c)D(pM ).
18

Let P : (−∞, 1] → R be a function from the set of feasible profitability levels defined
as a fraction of the monopoly profit (−∞, 1] to the set of prices R. If there are
multiple prices that yield the same level of profits then sellers can undercut the
competitor by posting the lowest of such prices thus this function finds the lowest
price that implements a profit level aΠM , a ∈ (−∞, 1]. That is, P is described by
P (a) = min{p ∈ R | (p − c)D(p) = aΠM },
since D is continuous and
lim (p − c)D(p) = −∞
p↓−∞
by the intermediate value theorem for any a ∈ (−∞, 1) there exists a p ∈ (−∞, pM )
such that (p − c)D(p) = aΠM , thus the pricing function P exists.
Note that in this case the function D is a function of the number of buyers who
purchase from the seller and not of the quantity that is sold. Thus, the evolution
of awareness is same as the case of unit demand. Therefore, it is straightforward
to check that the equilibrium pricing distributions in this environment are simply
composite functions of P and the price distributions in the main body of the paper:
the equilibrium price distribution F̃tj for seller j in period t, is F̃tj (P (a)) = Ftj (a).
5.2.2 The model with N > 2 sellers
Consider an extension of the model with N > 2 sellers. Let mt = (mjt )N j=1 be the
j
customer base profile in some period t ∈ {0, 1, 2}. Let J = {j : m2 = maxh (mh2 )h },
the set of sellers with the largest customer base and J 0 = {j : mj2 = maxh∈J h
/ (m2 )h }
be the set of sellers with the second largest customer base.

For period 2 the equilibrium is described by the proposition below:
Proposition 2. Given an awareness profile m2 in period 2 there is a unique equi-

librium strategy profile F 2 and a sharing rule that gives priority to sellers outside of
J over sellers in J if there is a tie in prices. The strategy profile F2 is such that for
a seller j ∈ J,
(i) The union of the supports of the profile of strategies F 2 form an interval [p2 , p2 ],
19

j
that is ∪N
j=1 supp(F2 ) = [p2 , p2 ]. This interval [p2 , p2 ] is such that
Y
p2 = (1 − mh2 )
h6=j
p2 = 1.
(ii) The supports of the strategies of individual sellers h ∈ {1, . . . , N } satisfy
supp(F2h ) = [p2 , ph2 ],
where for j 0 ∈ J 0 ,  j
 1−mh2 if |J| > 1
1−m2
ph2 = 0
1−mj2

1−mh
else.
2
(iii) For each h ∈ {1, . . . , N }, the profile of distribution F 2 is given by

Y
p [1 − mk2 F2k (p)] = p2 ,
k6=h
thus for a pair of sellers h and k, and a price p ∈ supp(F2h ) ∩ supp(F2k ) then
mh2 F2h (p) = mk2 F2k (p). (13)
(iv) The average price for transactions (sales) p can be written as a function of the
awareness profile p̂(m2 ) and it satisfies
p N j
P
j=1 m
p̂(m2 ) = . (14)
1− N
Q j)
j=1 (1 − m
Proof. For simplicity of notation consider the sorting of N sellers into types defined
in terms of their customer bases, described by the profile m2 = (mj2 )N j=1 . Let nk be
k
number of sellers of a type k and m be the customer base of these sellers. Types are
ordered by size such that for a type k = 2, . . . , K, mk > mk−1 .
The proof is divided into two steps. First an equilibrium is constructed then it is
shown that this equilibrium is unique.
Step 1: Construction of the candidate equilibrium
20

Consider the following profile candidate equilibrium for seller j ∈ {1, ..., N }:
supp(F2j ) = [p2 , pj2 ]
where 
 1−mKj if nK > 1
j 1−m2
p =
 1−mK−1 else
1−mj2
and
K−1
Y
p2 = (1 − mk )nk (1 − mK )nk −1 .
k=1
Consider a strategy profile F 2 = (F2j )N

j=1 , that satisfies the following set of N equal
profit conditions for p ∈ [p2 , pj2 ],
Y
p 1 − F2j (p)mj 1 − F2h (p)mh = p,

(15)
h6=j
which implies in a unique strategy profile F 2 .

Note that for p ∈ supp(F2j ) ∩ supp(F2h ) then
mh2

F2j (p) = F2h (p). (16)
mj2
Note that if nK = 1 then there is an atom of measure (1 − mK )/(1 − mK−1 ) at the

monopoly price 1 for the distribution of the firm with the largest customer base. The
sharing rule that favors other sellers against seller of type K in the case of a tie in
prices implies that F 2 is consistent with equilibrium. To see that note that buyers
shop at the lower type K−1 sellers if they post the monopoly price of 1 vis the type
K, which implies that the equal profit condition 15 holds for the seller of type K − 1
as well.
The equal profit condition implies that for an arbitrary seller j to post a price on the
support of F2j yields the same expected profits. It remains to show that there are no
profitable deviations for j, to check that it suffices to note that posting prices outside
of the support yield lower profits: For p ∈ [0, p2 ),
Πk (p, F −k k −k
2 , m2 ) < Π (p2 , F 2 , m2 ), (17)
21

and for p ∈ (pj , 1],
Πk (p, F −k k j −k
2 , m2 ) < Π (p , F 2 , m2 ). (18)
To see why the inequality 18 holds note that equal profit conditions imply in a strategy
profile that keeps at least two sellers with a larger customer base than j indifferent
between p and pj . Seller j’s demand is more elastic than sellers with larger customer
base therefore for seller j the gain in quantity from selling at the lower price pj
compared to p is higher than the loss in profits.
To see how the average price for transactions 14 is derived note that the expected
average price (which is equal to the average profit margin since marginal costs are
assumed to be zero) for transactions in equilibrium is determined by the profile of
price posting strategies of each seller which Proposition 2 states is determined by the
profile of awareness parameters m2 = (mj2 )N j=1 . Therefore we can write the expected
average price for transactions as a function of the awareness profile p̂(m2 ) , and it is
given by
p̂(m2 ) = E[min{pj }j∈Ai2 | Ai 6= ∅, m2 ]. (19)
In equilibrium, a seller’s expected revenue are pmj and the aggregate quantity sold
is 1 − N j
Q
j=1 (1 − m2 ) (as buyers purchase the good as long as they are aware of at
least one seller). This implies that p̂(m2 ) can be written as 14. That is, the expected
average price for transactions is given by the expected aggregate revenue of all sellers
divided by the quantity sold.
Step 2: Proof of Uniqueness of Equilibrium
The equilibrium is also unique. Too see that note first that the upper bound of the
support for at least a pair of sellers must include the monopoly price, otherwise a
seller has the incentive to deviate by posting the monopoly price. The union of the
supports for the strategies must be convex; otherwise sellers could increase profits
by posting prices in the complement of the support. Additionally, the supports for
the mixed strategies of individual sellers must be convex; otherwise the equal-profit
condition will be violated.
Further, equal-profit conditions are required to hold in a mixed strategy equilibrium
and these conditions imply that when the interior of the supports overlap, Equation
16 holds. This implies that, assuming no atoms at the lower bound of the support
of the distribution, the lower bound of the supports for any pair of seller types must
22

be the same if the interior of the supports overlap. Which implies that equilibrium
strategies for all seller types have convex supports. In addition, note that there
cannot be atoms at a lower bound of the support of equilibrium price distributions;
otherwise other sellers have the incentive to undercut.
It remains to show that in any equilibrium the interior of the supports of any pair of
sellers overlap. To see that, without loss of generality, suppose there is an equilibrium
strategy profile F̃ 2 such that all sellers of type k post prices according to a distribution
F2k with support [pk , pk ], and suppose that this support’s interior is disjointed from
the supports of the price posting strategies of all other sellers, whose union is [p, 1]
(thus pk ≤ p).
Note that the profits per unit of customer base for type k in this candidate equilibrium
are
Πk (pk )/mk = pk (1 − mk )nk −1 . (20)
For a seller of type h 6= k, profits are
Πh (p)/mh = p(1 − mk )nk , (21)
as seller of type h undercuts all competitors except sellers of type k. Note that pk ≤ p.
Therefore, the equal-profit condition for k and equation 21 implies that if F̃ 2 is an
equilibrium that
pk ≥ p(1 − mk )nk −1 . (22)
Therefore, expressions 21 and 22 imply that
Πh (pk )/mh = pk > p(1 − mk )nk = Πh (p)/mh , (23)
where Πh (p)/mh is the profit of seller of type h 6= k to post p, undercutting all

sellers except type k. Thus, the inequality 23 is a contradiction with F̃ 2 being an
equilibrium. Therefore, in equilibrium the interior of the supports must overlap.
If the interior of the supports of all types overlap then the equal profit conditions
imply that mixed strategies of each type satisfy equation 16 which implies that all
seller types share the same lower bound of the support p. Hence, the equal-profit
conditions imply that the equilibrium profile of price distributions is unique. As in
this case, all equal-profit conditions will satisfy equation 16, which yields the unique
23

strategy profile F 2 = (F2j )N
j=1 .
To check that the only sharing rule consistent with equilibrium is a sharing rule that
prioritizes the lower type sellers note that in any equilibrium in mixed strategies the
indifference condition implies that if there is an atom on the distribution of prices
then the sharing rule gives preference to the type that is not playing the strategy
with the atom. Then note that only the distribution of prices for type K, F2K , might
have an atom, so the sharing rule only has to give priority to types lower than K.
To extend the model for N > 2 sellers in period 1 define a value function v2 (m2 ) =
v2 (mj2 , m−j
2 ) for each possible vector of customer bases m2 in period 2. Thus v2 (m2 )
are the profit levels of firm j in the equilibrium described in the proposition above.
Then, construction of the equilibrium in period 1 is similar to the construction of the
equilibrium in period 2. The main difference is that now the potential lower bound
in prices includes the value function v2 so the seller with the largest customer base
is not necessarily the seller who posts the highest expected prices in equilibrium (as
it was shown in the two seller case). In equilibrium, as in period 2, the sharing rule
gives priority to other sellers vis the seller who posts the highest expected prices in
the case of a tie in prices.
24

References
[1] Mark Armstrong and John Vickers. “Patterns of Price Competition and the
Structure of Consumer Choice”. In: (2020). Working paper.
[2] Jonathan Baker. “Predatory Pricing after Brooke Group: An Economic Per-
spective”. In: Antitrust Law Journal 62 (1994), pp. 585–604.
[3] David Besanko, Ulrich Doraszelki, and Yaroslav Kryukov. “The Economics of
Predation: What Drives Pricing When There Is Learning-by-Doing?” In: Amer-
ican Economic Review 104 (2014), pp. 868–897.
[4] David Besanko, Ulrich Doraszelski, and Yaroslav Kryukov. “How Efficient Is
Dynamic Competition? The Case of Price as Investment”. In: American Eco-
nomic Review 109.9 (2019), pp. 3339–3364.
[5] Patrick Bolton, Joseph F. Brodley, and Michael H. Riordan. Predatory Pricing:
Strategic Theory and Legal Policy. The United States Department of Justice:
Antitrust Division. 2000. url: https://www.justice.gov/atr/predatory-
pricing-strategic-theory-and-legal-policy.
[6] Kenneth Burdett and Kenneth L. Judd. “Equilibrium Price Dispersion”. In:
Econometrica 51.4 (1983), pp. 955–969.
[7] Gerard R. Butters. “Equilibrium Distributions of Sales and Advertising Prices”.
In: Review of Economic Studies 44.3 (1977), pp. 465–491.
[8] Yongmin Chen and Robert W. Rosenthal. “Dynamic Duopoly with Slowly
Changing Customer Loyalties”. In: International Journal of Industrial Orga-
nization 14 (1996), pp. 269–296.
[9] Eddie Dekel, Barton L. Lipman, and Aldo Rustichini. “Standard State Space
Models Preclude Unawareness”. In: Econometrica 66.1 (1998), pp. 159–173.
[10] Emin M. Dinlersoz and Mehmet Yorukoglu. “Information and Industry Dy-
namics”. In: American Economic Review 102.2 (2012), pp. 884–913.
[11] Arthur Fishman and Rafael Rob. “Is Bigger Better? Customer Base Expansion
through Word-of-Mouth Reputation”. In: Journal of Political Economy 113.5
(2005), pp. 1146–1162.
25

[12] Lucia Foster, John Haltiwanger, and Chad Syverson. “Reallocation, firm turnover,
and efficiency: Selection on productivity or profitability?” In: American Eco-
nomic Review 98.1 (2008), pp. 394–425.
[13] Lucia Foster, John Haltiwanger, and Chad Syverson. “The Slow Growth of New
Plants: Learning about Demand?” In: Economica 84.329 (2016), pp. 91–129.
[14] S. Gilbukh and P. Roldan. “Firm Dynamics and Pricing under Customer Cap-
ital Accumulation”. In: Journal of Monetary Economics (2020). Forthcoming.
[15] François Gourio and Leena Rudanko. “Customer Capital”. In: Review of Eco-
nomic Studies 81.3 (2014), pp. 1102–1136.
[16] Rafael R. Guthmann. “Price Dispersion in Dynamic Competition”. Working
paper. 2020.
[17] Aviad Heifetz, Martin Meier, and Burkhard C. Schipper. “Interactive unaware-
ness”. In: Journal of Economic Theory 130.1 (2006), pp. 78–94.
[18] Norman J. Ireland. “The Provision of Information in Bertrand Oligopoly”. In:
The Journal of Industrial Economics 41 (1993), pp. 61–76.
[19] Greg Kaplan et al. “Relative Price Dispersion: Evidence and Theory”. In: Amer-
ican Economic Journal: Microeconomics 11.3 (2019), pp. 68–124.
[20] Edi Karni and Marie-Louise Vierø. “Awareness of unawareness: A theory of
decision making in the face of ignorance”. In: Journal of Economic Theory 168
(2017), pp. 301–328.
[21] Edi Karni and Marie-Louise Vierø. “Reverse Bayesianism: A Choice-Based
Theory of Growing Awareness”. In: American Economic Review 103.7 (2013),
pp. 2790–2810.
[22] Paul Klemperer. “Markets with Consumer Switching Costs”. In: Quarterly
Journal of Economics 102.2 (1987), pp. 375–394.
[23] R. Preston McAfee. “Endogenous Availability, Cartels, and Merger in an Equi-
librium Price Dispersion”. In: Journal of Economic Theory 62 (1994), pp. 24–
47.
[24] R. Preston McAfee. “Multiproduct Equilibrium Price Dispersion”. In: Journal
of Economic Theory 67 (1995), pp. 83–105.
26

[25] Guido Menzio and Nicholas Trachter. “Equilibrium Price Dispersion with Se-
quential Search”. In: Journal of Economic Theory 160.6 (2015), pp. 188–215.
[26] Paul Milgrom and John Roberts. “Reputation, Predation, and Entry Deter-
rence”. In: Journal of Economic Theory 27 (1982), pp. 280–312.
[27] Salvatore Modica and Aldo Rustichini. “Unawareness and Partitional Informa-
tion Structures”. In: Games and Economic Behavior 27.2 (1999), pp. 265–298.
[28] Luigi Paciello, Andrea Pozzi, and Nicholas Trachter. “Price Dynamics with
Customer Markets”. In: International Economic Review 60.1 (2019), pp. 413–
446.
[29] Jesse Perla. “Product Awareness, Industry Life Cycles, and Aggregate Profits”.
Working Paper. 2019.
[30] Leonard J. Savage. The Foundations of Statistics. New York, United States:
Wiley, 1954.
[31] Burkhard C. Schipper. “Unawareness - A gentle introduction to both the liter-
ature and the special issue”. In: Mathematical Social Sciences 70 (2014), pp. 1–
9.
[32] Leo K. Simon and William R. Zame. “Discontinuous Games and Endogenous
Sharing Rules”. In: Econometrica 58.4 (1990), pp. 861–872.
[33] Alan T. Sorensen. “Equilibrium Price Dispersion in Retail Markets for Pre-
scription Drugs”. In: Journal of Political Economy 108.4 (2000), pp. 833–850.
[34] Nora Szech. “Welfare in Markets where Consumers Rely on Word of Mouth”.
mimeo. 2011.
[35] Hal R. Varian. “A Model of Sales”. In: American Economic Review 70.4 (1980),
pp. 651–659.
27

Imperfect Competition from Unawareness

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Imperfect Competition from Unawareness

Uploaded by

Copyright:

Available Formats

Imperfect Competition as a Result of Unawareness

This paper develops a dynamic model of price competition where buyers

Keywords: Price competition, discovery, equilibrium price dispersion

Electronic copy available at: https://ssrn.com/abstract=3710809

Electronic copy available at: https://ssrn.com/abstract=3710809

Electronic copy available at: https://ssrn.com/abstract=3710809

1.1 Related literature

Electronic copy available at: https://ssrn.com/abstract=3710809

Electronic copy available at: https://ssrn.com/abstract=3710809

2.1 Physical environment

Electronic copy available at: https://ssrn.com/abstract=3710809

Figure 1: Venn diagram of the set of buyers categorized by consideration sets.

2.2 Discovery and memory loss

µ(D(q1j ), 1 − mj1 ) = (1 − mj1 )D(q1j ).

Electronic copy available at: https://ssrn.com/abstract=3710809

2.3 Strategies and payoffs

S(p, Fth , mt ) = (1 − mht ) + mht [1 − Fth (p)] (2)

Electronic copy available at: https://ssrn.com/abstract=3710809

π(p, Fth , mt ) = mjt pS(p, Fth , mt ), (3)

π(p, F1h , m1 ) + βE[π(p, F2h , m2 ) | p, F1h , m1 ],

where p is a price on the support of j’s equilibrium price distribution in period t

Electronic copy available at: https://ssrn.com/abstract=3710809

3.1 Characterization of the unique subgame perfect equilib-

Proposition 1. Equilibrium is unique and features non-generate distributions of

Electronic copy available at: https://ssrn.com/abstract=3710809

p1 mj1 + βv2j (mj2 , mh2 )

Electronic copy available at: https://ssrn.com/abstract=3710809

lim F1j (p) < 1.

Electronic copy available at: https://ssrn.com/abstract=3710809

Electronic copy available at: https://ssrn.com/abstract=3710809

Corollary 1. If the dynamic gain in payoffs (given by equation 4) satisfies

Corollary 2. If ∆I − ∆E = mI1 − mE 1 then both sellers post prices according to

Electronic copy available at: https://ssrn.com/abstract=3710809

Figure 2: The equilibrium price distributions in period 1 featuring ”predatory pric-

Electronic copy available at: https://ssrn.com/abstract=3710809

Electronic copy available at: https://ssrn.com/abstract=3710809

5.1 Independence of Awareness

Electronic copy available at: https://ssrn.com/abstract=3710809

Pr(E ∈ Ait+1 : I ∈ Ait+1 ) = Pr(E ∈ Ai : I ∈

Therefore, independence holds for the period t + 1. Independence is assumed to hold

Electronic copy available at: https://ssrn.com/abstract=3710809

P (a) = min{p ∈ R | (p − c)D(p) = aΠM },

since D is continuous and

5.2.2 The model with N > 2 sellers

be the set of sellers with the second largest customer base.

Proposition 2. Given an awareness profile m2 in period 2 there is a unique equi-

Electronic copy available at: https://ssrn.com/abstract=3710809

(ii) The supports of the strategies of individual sellers h ∈ {1, . . . , N } satisfy

supp(F2h ) = [p2 , ph2 ],

(iii) For each h ∈ {1, . . . , N }, the profile of distribution F 2 is given by

mh2 F2h (p) = mk2 F2k (p). (13)

Electronic copy available at: https://ssrn.com/abstract=3710809

supp(F2j ) = [p2 , pj2 ]

Consider a strategy profile F 2 = (F2j )N

which implies in a unique strategy profile F 2 .

Note that if nK = 1 then there is an atom of measure (1 − mK )/(1 − mK−1 ) at the

Electronic copy available at: https://ssrn.com/abstract=3710809

Electronic copy available at: https://ssrn.com/abstract=3710809

For a seller of type h 6= k, profits are

Πh (p)/mh = p(1 − mk )nk , (21)

Therefore, expressions 21 and 22 imply that

Πh (pk )/mh = pk > p(1 − mk )nk = Πh (p)/mh , (23)