WEW-012
From Economics
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[edit] Microeconomics Question from Walter E. Williams:
"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."
[edit] Answer
Def:
Percentage of Income: ratio of the price of the item to overall income
- Income elasticity:
- As income increases do you by more of the good in a unitary proportion to the increase in income (unitary elastisity)? example: ?clothing?.
- If income goes up by a dollar do you buy less of a certain item (in percentage terms)? for example: drinking water
- 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]
- Real World Example (1) The buyer searches a little:
Chewing gum. For example if one was in the convienence store at GMU looking for chewing gum it would be unlikely that that person would go to a store off campus to find the desire source of chewing gum. Because this is such a small purchase and does not represent a good which increases disproportionately with income increases, we expect that the best decesion which can be made in this opportunity set will prevail. - Real World Example (2) The buyer searches a lot: 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. The ones in the retail stores are different from the ones that are custom made. Assuming that a computer purchase reflects both a large protion of disposable income as well as the fact that additional ammounts of income are likely to change the price point of the ultimately choosen computer machine, theory would suggest that one 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 life 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.
[edit] Sources
Hirshleifer, Glazer, Hirshleifer. Price Theory and Applications: Decisions, Markets, and Information (2005 - Seventh edition)
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