The Law of One Price?
The Impact of IT-Enabled Markets on Consumer Search and Retailer Pricing
Michael D. Smith
H. John Heinz III School of Public Policy and Management
Carnegie Mellon University
4800 Forbes Avenue
Pittsburgh, PA 15213
IT research has analyzed how the performance of IT-enabled markets may differ
from conventional markets. This literature has made two unexpected empirical
findings. First, IT-enabled markets for commodity goods exhibit significant
price dispersion. Second, well-known retailers in these markets appear to
cooperate to set high prices.
paper presents an analytic model, and confirmatory empirical evidence, that
explains this behavior as a response to the unique characteristics of consumer
search in electronic markets. In conventional markets, consumer search costs are
primarily a function of the consumerís physical proximity to retailer outlets
ó and physical proximity is distributed relatively equally across retailers.
In electronic markets, consumer search costs are primarily a function of the
consumerís mental awareness of different retailers ó and this awareness is
likely to be concentrated in the hands of a few retailers.
on this model of consumer search, IT-enabled markets for commodity goods exhibit
high price dispersion in equilibrium and a few well-known retailers are able to
cooperate to set high prices. The predictions of the model are shown to be
consistent with empirical data for 23,744 books collected from 24 Internet
retailers in late 1999. Viewing consumer search in this manner provides a useful
starting point for understanding the likely development of IT-enabled markets,
and for understanding the importance of advertising and first-mover advantage
for electronic market participants.