## Question from Past Microeconomics Qualifying Exam

Spring 1999- Section I, Question four, George Mason University

True, False, Uncertain. Determine whether or not each of the following statements are true or false. Explain your reasoning briefly in a paragraph or two. (The explanation is often more important than the answer given). Include a carefully labeled diagram or game matrix if it helps to clarify your answer.

The gain from search activity is related to the dispersion of prices charged by different sellers. The gain is also related to the fraction of the individual’s income spent on the good and its income elasticity.

True According to Stigler (1961), there are two benefits to searching more. First, you will get better quotes. Second, you will acquire better knowledge about the distribution of prices. The cost of searching is the opportunity cost of your time. If prices are widely dispersed you will do better to spend more time searching, if prices are not widely dispersed you will do better to spend less time searching. Therefore, the gain from search activity is related to the dispersion of prices.

The larger the fraction of the buyer’s expenditures on the commodity, the greater the savings from search time (and hence the greater the amount of search). The more inelastic the income elasticity, the more needed is the good. Thus, the individual will reap sizable gains for a search that compresses price dispersion.

See Stigler (JPE, 1961) Your optimal amount of time searching will increase whenever:

• The variance of quotes is higher (thin markets)
• The expenditure is larger (one time or repeat purchases)
• Your opportunity cost of time is lower
• You have better search technology
• Quotes are less correlated across time – each quote conveys additional info about the distribution

Since prices are positively correlated, increased search time will lead to a decrease in the dispersion of prices, so increased search time will yield significant results. The larger the fraction of the buyer’s expenditures on the commodity, the greater the savings from search time (and hence the greater the amount of search). The more inelastic the income elasticity, the more needed is the good. Thus the individual will reap sizable gains for a search that compresses price dispersion.

## Sources

• George J. Stigler, The Journal of Political Economy, Vol. 69, No. 3. (Jun., 1961), pp. 213-225.
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