DP12046 Product Choice and Price Discrimination in Markets with Search Costs

Author(s): Natalia Fabra, Juan Pablo Montero
Publication Date: May 2017
Keyword(s): retail competition., search, second degree price discrimination, vertical differentiation
JEL(s):
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12046

In a seminal paper, Champsaur and Rochet (1989) showed that competing firms choose non-overlapping qualities so as to soften price competition at the cost of giving up profitable opportunities to price discriminate. In this paper we show that an arbitrarily small amount of search costs is enough to give rise to an equilibrium with overlapping qualities. In markets with search costs, competing firms face the monopolist's incentive to price discriminate, which induces them to offer the full quality range even if this forces them to compete head-to-head. Hence, even though search costs increase prices and reduce consumers surplus for given quality choices, search costs can also lead to lower prices and higher consumer surplus whenever they induce firms to offer broader and overlapping product lines. Our analysis also provides predictions regarding pricing by multi-product firms in markets with search costs under various retail market structures. Product choices and pricing by online bookstores motivate our findings.