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Microeconomics Question from Walter E. Williams:Edit

"Explain the following accurate statement: 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 of the good and its income elasticity. Give a real world example of a good whereby the buyer searches a little and another good whereby the buyer searches a lot. Explain why."

AnswerEdit

Def:
Percentage of Income: ratio of the price of the item to overall income

  1. Income elasticity:
    1. As income increases do you buy more of the good in a unitary proportion to the increase in income (unitary elasticity)? For example: clothing.
    2. If income goes up by a dollar do you buy less of a certain item (in percentage terms)? For example: drinking water.
    3. If income increases by a dollar do you buy more of a certain item (in percentage terms)? For example: cigarettes/alcohol for the non-rich smokers/drinkers --or-- housing for the rich. [1]
  2. Minimal search effort exerted. Real world example: Chewing gum.
    A buyer in the convienence store at GMU interested in acquiring chewing gum would be unlikely to leave campus simply to compare chewing gum prices elsewhere. Because chewing gum is such a small purchase as a percentage of income and does not represent a good which increases in proportion with increases to income, we expect that the best decesion which can be made, given this opportunity set, will prevail.
  3. Large search effort exerted. Real world example: Laptop computer.
    When buying a new laptop computer a buyer is likely to look at many different sources. The computers which are available from Apple are different from those available from Dell or Gateway. Those available in the big-box retail stores are different from the ones that are custom-ordered and manufactured. Assuming that a computer purchase reflects both a large portion of disposable income as well as the fact that additional amounts of income are likely to increase buyer's willingness to pay, and ultimately the price point of the machine the buyer purchases, theory would suggest that a buyer would search much longer towards the purchase of a new computer.

(Another factor to consider for at least this decision is that the computer will have a longer serviceable lifespan than the gum; this might already be accounted for in the income elasticity, however.)

Formula: The potential gains from search are greater when there is more variation in price. Therefore, if there is relatively little variation, it doesn’t make sense to spend much time in search. Individuals will continue to search for a lower price only so long as the marginal decrease in price is greater than the marginal cost of additional search.

SourcesEdit

Hirshleifer, Glazer, Hirshleifer. Price Theory and Applications: Decisions, Markets, and Information (2005 - Seventh edition)

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