Working Paper No. 09-08

Price-Directed Consumer Search
Tianle Zhang
November 2009

ABSTRACT

This paper presents an oligopoly model in which consumers conduct sequential costly search for a desired product. In contrast to the specification of random or pre-determined search order in most current studies, I allow the order of consumer search to be endogenously determined. In the model, consumers observe product prices before searching among firms. Thus, price additionally affects profit by influencing the order in which consumers search. I find that the pattern of equilibrium price distribution depends on the size of search cost. In particular, for a medium search cost, a mixture price distribution prevails: firms randomly play two separate price distributions with a gap in between. Firms either price high, following a high price distribution, or price low, following a low price distribution, but always avoid prices at the intermediate interval. For low or high search costs, equilibrium price distribution is continuous with positive density on the entire support. Comparative statics show that equilibrium price is non-monotonic in search cost and firm profit can be higher when consumers have lower search costs.

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