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An Empirical Model of Search with Vertically Differentiated Products

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  • Matthijs R Wildenbeest

    (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)

Abstract

This paper presents a non-sequential search model that allows for vertical product differentiation. In the unique symmetric equilibrium firms with different characteristics draw utilities from a common utility distribution, resulting in asymmetric price distributions. The model therefore provides a theoretical rationale for explaining price dispersion as a result of quality differences and search frictions together. More specifically, the model can explain the frequent and asymmetric price changes reported in several empirical papers, but also why some firms have persistently higher prices than others. Using the equilibrium conditions derived from the model, we show how to estimate search costs by maximum likelihood using only prices. The method is applied to a data set of prices for grocery items from supermarkets in the UK. Estimates reveal that most of the observed price variation can be explained by supermarket heterogeneity and that the estimated amount of search is low in this market. We show that ignoring vertical product differentiation results in an overestimation of search costs. Moreover, estimated search costs using a basket of organic items are on average higher than that of a similar non-organic basket. We also simulate how changes in search costs will affect behavior of stores and consumers.

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Bibliographic Info

Paper provided by Indiana University, Kelley School of Business, Department of Business Economics and Public Policy in its series Working Papers with number 2009-01.

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Date of creation: Apr 2009
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Handle: RePEc:iuk:wpaper:2009-01

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Keywords: consumer search; product differentiation; price dispersion; structural estimation;

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References

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  1. Matthew Lewis, 2008. "PRICE DISPERSION AND COMPETITION WITH DIFFERENTIATED SELLERS -super-* ," Journal of Industrial Economics, Wiley Blackwell, vol. 56(3), pages 654-678, 09.
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  3. Saul Lach, 2002. "Existence and Persistence of Price Dispersion: an Empirical Analysis," NBER Working Papers 8737, National Bureau of Economic Research, Inc.
  4. Howard Smith, 2004. "Supermarket Choice and Supermarket Competition in Market Equilibrium," Review of Economic Studies, Oxford University Press, vol. 71(1), pages 235-263.
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  14. Michael R. Baye & John Morgan & Patrick Scholten, 2006. "Information, Search, and Price Dispersion," Working Papers 2006-11, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
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  16. Wolinsky, Asher, 1986. "True Monopolistic Competition as a Result of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 101(3), pages 493-511, August.
  17. Jose Luis Moraga-Gonzalez & Matthijs R. Wildenbeest, 0000. "Maximum Likelihood Estimation of Search Costs," Tinbergen Institute Discussion Papers 06-019/1, Tinbergen Institute.
  18. repec:rje:randje:v:37:y:2006:2:p:257-275 is not listed on IDEAS
  19. Martin Pesendorfer, 2002. "Retail Sales: A Study of Pricing Behavior in Supermarkets," The Journal of Business, University of Chicago Press, vol. 75(1), pages 33-66, January.
  20. Howard Smith, 2006. "Store characteristics in retail oligopoly," RAND Journal of Economics, RAND Corporation, vol. 37(2), pages 416-430, 06.
  21. Armstrong, Mark, 2008. "Interactions between competition and consumer policy," MPRA Paper 7258, University Library of Munich, Germany.
  22. Maarten C. W. Janssen & José Luis Moraga-Gonz�lez, 2004. "Strategic Pricing, Consumer Search and the Number of Firms," Review of Economic Studies, Oxford University Press, vol. 71(4), pages 1089-1118.
  23. Morgan, Peter & Manning, Richard, 1985. "Optimal Search," Econometrica, Econometric Society, vol. 53(4), pages 923-44, July.
  24. Howard Smith, 2004. "Supermarket Choice and Supermarket Competition in Market�Equilibrium," Review of Economic Studies, Wiley Blackwell, vol. 71(1), pages 235-263, 01.
  25. Ali Hortaç Su & Chad Syverson, 2004. "Product Differentiation, Search Costs, And Competition in the Mutual Fund Industry: A Case Study of S&P 500 Index Funds," The Quarterly Journal of Economics, MIT Press, vol. 119(2), pages 403-456, May.
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Citations

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Cited by:
  1. Lach, Saul & Moraga, Jose L., 2009. "Asymmetric price effects of competition," IESE Research Papers D/797, IESE Business School.
  2. Haizhen Lin & Matthijs R. Wildenbeest, 2013. "Search and Prices in the Medigap Insurance Market," Working Papers 2013-15, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  3. Babur De los Santos & Ali Hortacsu & Matthijs R. Wildenbeest, 2012. "Search with Learning," Working Papers 2012-03, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  4. Jason Allen & Robert Clark & Jean-François Houde, 2014. "Search Frictions and Market Power in Negotiated Price Markets," NBER Working Papers 19883, National Bureau of Economic Research, Inc.
  5. Giacomo Pasini & Paolo Pin & Simon Weidenholzer, 2008. "A Network Model of Price Dispersion," Working Papers 2008.28, Fondazione Eni Enrico Mattei.
  6. Jason Allen & Robert Clark & Jean-François Houde, 2013. "The Effect of Mergers in Search Market: Evidence from the Canadian Mortgage Industry," NBER Working Papers 19126, National Bureau of Economic Research, Inc.
  7. Rauh, Michael T., 2009. "Strategic complementarities and search market equilibrium," Games and Economic Behavior, Elsevier, vol. 66(2), pages 959-978, July.
  8. Ian McCarthy & Rusty Tchernis, 2008. "Search Costs and Medicare Plan Choice," Caepr Working Papers 2008-004, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
  9. Jose Luis Moraga-Gonzalez & Zsolt Sandor & Matthijs R. Wildenbeest, 2008. "Nonparametric Estimation of the Costs of Non-Sequential Search," Tinbergen Institute Discussion Papers 07-102/1, Tinbergen Institute.
  10. Saul Lach & Jose Luis Moraga-Gonzalez, 2009. "Asymmetric Price Effects of Competition," Tinbergen Institute Discussion Papers 09-049/2, Tinbergen Institute.

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