DP14036 Information Acquisition and Diffusion in Markets
Consumers can acquire information through their own search efforts or through their social network. Information diffusion via word-of-mouth communication leads to some consumers free-riding on their "friends" and less information acquisition via active search. Free-riding also has an important positive effect, however, in that consumers that do not actively search themselves are more likely to be able to compare prices before purchase, imposing competitive pressure on firms. We show how market prices depend on the characteristics of the network and on search cost. For example, if the search cost becomes small, price dispersion disappears, while the price level converges to the monopoly level, implying that expected prices are decreasing for small enough search cost. More connected societies have lower market prices, while price dispersion remains even in fully connected societies.