Price setting, price dispersion, and the value of money: or, the law of two prices$

We study models combining search, money, price posting, and preference shocks. We show how these features interact to influence the price level andprice dispersion. First, price-posting equilibria exist with valued fiat currency. Second, although both are possible, price dispersion is more common than a single price. Third, we prove that generically there cannot be more than two prices. We provide intuition for this law of two prices, show it also holds in some nonmonetary search models, and discuss variations of the assumptions under which it may not hold. r 2004 Elsevier B.V. All rights reserved