Price Dispersion and Inflation: Evidence from Israel

Abstract

This paper considers the question of whether observed price differe ntials reflect perceived differences in quality, service agreements, or location, or whether information imperfections can explain this phenomenon. It sets out theoretical arguments linking inflation to reductions in the information stock held by agents and thus to greater price dispersion. The hypothesis is tested using monthly price data for thirteen uniquely-defined goods sold in Israel between 1971 and 1984. Price dispersion is shown to be positively related to the rate of market price inflation. Since inflation is an unlikely proxy for changes in perceived characteristics, the findings support price dispersion theories based on "optimally imperfect" decision making. Copyright 1988 by University of Chicago Press.