DP12046 Product Choice and Price Discrimination in Markets with Search Frictions

Author(s): Natalia Fabra, Juan Pablo Montero
Publication Date: May 2017
Date Revised: May 2019
Keyword(s): retail competition, search, second degree price discrimination, vertical differentiation
Programme Areas: Industrial Organization
Link to this Page: 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. We show that an arbitrarily small amount of search frictions is enough to rule out such equilibrium. Instead, there exists an equilibrium with overlapping qualities and full price discrimination. This is in contrast to other sources of market power (e.g. horizontal product diferentiation), which have to be such ciently strong in order to give rise to overlapping qualities. Search frictions increase prices and reduce consumers surplus for given quality choices, but they can also lead to lower prices and higher consumer surplus as they induce firms to offer broader and overlapping product lines.