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.

We examine the incentives that owners of competing firms give their managers. We show that, in equilibrium, each manager will be paid in excess of his decision's marginal profit in a Cournot-quantity game, but paid less than the marginal profit in a price game. In the Cournot case, deviations from profit maximization are reduced by ex ante cost uncertainty and increased by correlation in the firms' costs.