Review of Industrial Organization 21: 305–324, 2002.
© 2002 Kluwer Academic Publishers. Printed in the Netherlands.
Price Dispersion on the Internet: Good Firms and
KATHY BAYLIS and JEFFREY M. PERLOFF
Department of Agricultural & Resource Economics, University of California, Berkeley, CA
Abstract. Internet ﬁrms charge a wide range of prices for homogeneous products, and high-priced
ﬁrms remain high-priced and low-priced ﬁrms remain low-priced over long periods. One explanation
is that high-price ﬁrms are charging a premium for superior service. An alternative, price-dispersion
explanation is that ﬁrms vary the prices for informed and uniformed consumers (Salop and Stiglitz,
1977) or serious shoppers and others (Wilde and Schwartz, 1979). The pricing pattern for a digital
camera and a ﬂatbed scanner is consistent with the price-dispersion model and inconsistent with the
According to conventional wisdom, e-commerce markets provide efﬁciency un-
paralleled in traditional markets (Bakos, 1991). Many authors have argued that
they these markets will eventually become competitive or will be typiﬁed by price
differentials due to variations in service. Our results reject these views.
A typical discussion of Internet retailing starts with the observation that e-
commerce has all of the characteristics associated with perfect competition.
Consumers can compare many ﬁrms’ prices with a click of a mouse, there are low
barriers to entry, and ﬁrms can change prices at low cost (Bailey, 1998; Brynolfsson
and Smith, 1999).
If indeed electronic markets were highly competitive we would expect at least
one of three hypotheses to be true. First, we would expect to see the emergence
of a perfectly competitive market where the law of one price prevails. Second,
even if the market were not perfectly competitive, we would expect ﬁrms to adjust
their prices regularly to undercut competitors, so that ﬁrms’ price-rankings vary
over time. Third, we would expect a tradeoff between price and services or fees,
where ﬁrms that provide services, offer guarantees, or assess low shipping and
other fees would charge higher prices to cover their extra costs. Using this latter
reasoning, Varian (1999) predicted that two groups of e-commerce retailers will
emerge: Those providing little service and low prices and those offering more
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