THE EFFECT OF INCOME INEQUALITY ON PRICE DISPERSION

Using a supply/demand consumer model with search, we show under what conditions the distribution of income within a community is related to the type of firms that exist within that community, impacting the level of prices. We assume that searching for the lowest price costs both time and money to the consumer. If time and money costs are high enough low-income consumers cannot afford the monetary cost of search, while wealthy consumer are not willing to take the time to look for the lowest price. The middle class have the right balance of time and money cost of search and therefore are the most aggressive shoppers. We use a supply side model of firm output and pricing strategy to demonstrate that firms located in more informed communities are more likely to enter the market as large low-priced retailers. By connecting these two results, we show under what conditions the size of the middle class can have a negative relationship with the level of prices in a local market. Our paper goes beyond other work on causes of price dispersion by allowing consumers to purchase a continuous amount of the good, and by incorporating a distribution of search costs. Both these modifications allow us to focus more specifically on the link between income distribution and prices.