Academic journal article Agricultural and Resource Economics Review

Bargaining, Search, and Price Dispersion: Evidence from the Live Hogs Market

Academic journal article Agricultural and Resource Economics Review

Bargaining, Search, and Price Dispersion: Evidence from the Live Hogs Market

Article excerpt

Using unique panel data on individual transactions between buyers and sellers in the spot market for live hogs, we found a large degree of intra-day price dispersion. Motivated by this empirical puzzle, we offer an explanation which is rooted in the bargaining with search theory. We formulate three hypotheses involving the role of farmers' search cost, bargaining parties' patience, and asymmetric information that we believe can explain the observed phenomenon. Empirical analysis shows strong support for all three of the stated theoretical predictions, indicating that the bargaining with search theory explains at least 31 percent of the observed intraday price variation in this market.

Key Words: intra-day price dispersion, bargaining theory, search cost, asymmetric information

In contrast to the standard neoclassical theory, in many markets we often observe that the same good is sold for different prices at different outlets. Starting with the original work of Stigler (1961), numerous studies have been devoted to explaining the phenomenon of price dispersion in markets for seemingly homogenous goods. Several possible explanations are put forward.1 One prominent explanation is the existence of search costs. Consumers incur positive search cost when searching for low prices, and in equilibrium consumers who search more pay a lower price than those who search less (Reinganum 1979, Mac- Minn 1980). Another explanation is based on informational asymmetry: some consumers are aware of the low price and some are not, and hence different consumers end up paying different prices (Varian 1980, Baye and Morgan 2001). Yet another explanation is rooted in various theories of imperfectly competitive markets. For example, Borenstein and Rose (1994) study dispersion in the prices an airline charges to different passengers on the same route and argue that the data supports models of price discrimination in monopolistically competitive markets.

Using the individual transaction data between buyers and sellers in the hog market, we found a large degree of intra-day price dispersion. These prices are negotiated in the so-called direct trades between farmers and pork packers. Even a casual observer of this industry would not be surprised by the high degree of price variation knowing that live animals are not homogenous goods, so why would they command a uniform price? The reason why this is a puzzle is because the prices that we use are the so-called base prices which are negotiated between a farmer and a packer before the quality has been measured. The actual price that a farmer will receive for his hogs is the sum of the negotiated base price and various premiums and discounts that will be added to the base price after the animal has been slaughtered and various quality attributes have been precisely measured. Our main objective is to try to explain this intra-day base price dispersion in a geographical segment (state of Iowa) of the live hogs market.

Although it is hard to contest the empirical observation that observed prices for otherwise homogeneous products differ across buyers and sellers in the same market and the same time, this does not necessarily mean that "the law of one price" should be automatically rejected. As pointed out by Baylis and Perloff (2002), price dispersion may be "illusory," a result of "hidden" price differentiation. That is, the same product sold in different transactions may actually be a differentiated product because the heterogeneity of buyers and sellers ends up being reflected in the product itself.

We formulate a theoretical explanation for the observed phenomenon using the insights from the bargaining with search theory. The empirical literature on bargaining with non-experimental (field) data is mainly concerned with labor unions and strikes (see Ausubel, Cramton, and Deneckere 2002). In addition to labor union contract negotiations, the empirical bargaining papers focus mainly on socioeconomic characteristics of the bargaining parties that effect bargaining outcomes (e. …

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