DP15967 Consumer Search and the Uncertainty Effect
We consider a model of Bertrand competition where consumers are uncertain about the
qualities and prices of firms' products. Consumers can inspect all products at zero cost.
A share of consumers is expectation-based loss averse. For these consumers, a purchase
plan, which involves buying products of varying quality and price with positive probability,
creates scale-dependent disutility from gain-loss sensations. Even if their degree
of loss aversion is modest, they may refrain from inspecting all products and choose an
individual default that is first-order stochastically dominated. Firms' strategic behavior
can exacerbate the scope for this "uncertainty effect", and sellers of inferior products may
earn positive profits despite Bertrand competition. We find suggestive evidence for the
predicted association between consumer behavior and loss aversion in new survey data.
