Joint Dynamics of Costs and Prices in Markets with Search Frictions

This paper studies price dynamics in a product markets characterized by: (a) search frictions— in the sense that it takes time for a buyer to find a seller that produces a version of the good he likes; (b) anonymity— in the sense that sellers cannot price discriminate between first-time buyers and returning costumers; (c) asymmetric information— in the sense that sellers are subject to idiosyncratic shocks to their marginal cost of production and privately observe the shocks' realizations. I find that the joint dynamics of costs and prices may be very different than in a standard Walrasian market. When shocks are i.i.d., the price remains constant in the face of fluctuations in a seller's marginal cost. When shocks are moderately persistent, the price adjusts slowly and imperfectly in response to changes in a seller's cost. Finally, when shocks are sufficiently persistent, the price adjusts instantaneously and efficiently as soon as a seller's production cost varies.

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