Greater search cost reduces prices

Abstract

Consumers learn their valuation for most goods and services sooner than the price or the availability. In such markets, the optimal price of each firm falls in the search cost of the consumers, despite the exit of lower-value consumers when search becomes costlier. The reason is that a greater search cost causes inframarginal consumers to exit instead of switching firms. The marginal consumers respond less and may become more numerous. The more elastic demand raises prices. At a high enough search cost, no consumer switches. Each firm is a monopolist but sets a lower price than under competition over the switchers because demand changes shape when some consumers exit. Total surplus, demand and profits fall in the search cost. Consumer surplus and total surplus are higher when consumers do not know their valuations. The results are robust to various changes of the assumptions, for example some consumers having zero search cost or firms running out of stock. Show more