Search theory has been extensively and successfully applied to explain the persistence of price dispersion. This paper presents an explicitly dynamic search model which is able to account for cyclical patterns of prices and demand over time. These cyclical features of the model are the consequence of the dynamic strategic interaction between buyers and firms and do not require the presence of extraneous factors such as shocks or heterogeneity of agents in order to obtain. The model builds on earlier work by Kenneth Burdett and Kenneth L. Judd and may be interpreted as a dynamic extension of their model.

technology ; prices ; costs

A model of gradual reputation formation through a process of continuous investment in product quality is developed. We assume that the ability to produce high‐quality products requires continuous investment and that as a consequence of informational frictions, such as search costs, information about firms’ past performance diffuses only gradually in the market. This leads to a dual process of growth of a firm’s customer base and an increase in the firm’s investment in quality. The model predicts, therefore, that the longer its tenure as a high‐quality producer, the more a firm invests in quality. We relate this finding to empirical work on online commerce as well as on traditional industries.