DP12326 Word of Mouth Communication and Search

Author(s): Arthur Campbell, Matthew Leister, Yves Zenou
Publication Date: September 2017
Keyword(s): giant component, inefficiencies, search, Social Networks
JEL(s): D83, D85, L15
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12326

In many economic contexts, the most credible source of information about the quality of products is one's friends. In this paper, we develop a word-of-mouth model of search for an experience good where the quality is unknown. We find the characteristics of the social net-work that result in exclusively low quality, a mixture of qualities and exclusively high-quality products. When consumer search is costly, an exclusively high-quality equilibrium is not possible. Moreover, markets may become stuck in a low-quality equilibrium when equilibria with better quality are possible. Market inefficiencies are characterized by an under-investment in friends and a market's misallocation of low-quality firms.