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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. 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.
  2. Moraga-González, José Luis & Wildenbeest, Matthijs R., 2008. "Maximum likelihood estimation of search costs," European Economic Review, Elsevier, vol. 52(5), pages 820-848, July.
  3. Saul Lach, 2002. "Existence And Persistence Of Price Dispersion: An Empirical Analysis," The Review of Economics and Statistics, MIT Press, vol. 84(3), pages 433-444, August.
  4. repec:rje:randje:v:37:y:2006:2:p:416-430 is not listed on IDEAS
  5. Michael R. Baye & John Morgan & Patrick Scholten, 2004. "Price Dispersion in the Small and in the Large: Evidence from an Internet Price Comparison Site," Working Papers 2004-03, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  6. Han Hong & Matthew Shum, 2006. "Using price distributions to estimate search costs," RAND Journal of Economics, RAND Corporation, vol. 37(2), pages 257-275, 06.
  7. repec:rje:randje:v:37:y:2006:2:p:257-275 is not listed on IDEAS
  8. 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.
  9. Mark Armstrong, 2008. "Interactions between Competition and Consumer Policy," CPI Journal, Competition Policy International, vol. 4.
  10. 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.
  11. Daniel Hosken & David Reiffen, 2004. "Patterns of Retail Price Variation," RAND Journal of Economics, The RAND Corporation, vol. 35(1), pages 128-146, Spring.
  12. Philip A. Haile & Han Hong & Matthew Shum, 2003. "Nonparametric Tests for Common Values at First-Price Sealed-Bid Auctions," NBER Working Papers 10105, National Bureau of Economic Research, Inc.
  13. 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.
  14. Stahl, Dale O, II, 1989. "Oligopolistic Pricing with Sequential Consumer Search," American Economic Review, American Economic Association, vol. 79(4), pages 700-712, September.
  15. Howard Smith, 2004. "Supermarket Choice and Supermarket Competition in Market Equilibrium," Review of Economic Studies, Oxford University Press, vol. 71(1), pages 235-263.
  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. Matt Shum & Phil Haile & Han Hong, 2003. "Nonparametric Tests for Common Values in First-Price Auctions," Economics Working Paper Archive 501, The Johns Hopkins University,Department of Economics.
  18. Babur de los Santos, 2008. "Consumer Search on the Internet," Working Papers 2008-06, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  19. Matthew Lewis, 2008. "PRICE DISPERSION AND COMPETITION WITH DIFFERENTIATED SELLERS -super-* ," Journal of Industrial Economics, Wiley Blackwell, vol. 56(3), pages 654-678, 09.
  20. Howard Smith, 2004. "Supermarket Choice and Supermarket Competition in Market�Equilibrium," Review of Economic Studies, Wiley Blackwell, vol. 71(1), pages 235-263, 01.
  21. Burdett, Kenneth & Judd, Kenneth L, 1983. "Equilibrium Price Dispersion," Econometrica, Econometric Society, vol. 51(4), pages 955-69, July.
  22. Yingyao Hu & Matthew Shum, 2007. "Estimating First-Price Auctions with an Unknown Number of Bidders: A Misclassification Approach," Economics Working Paper Archive 541, The Johns Hopkins University,Department of Economics.
  23. Morgan, Peter & Manning, Richard, 1985. "Optimal Search," Econometrica, Econometric Society, vol. 53(4), pages 923-44, July.
  24. Howard Smith, 2006. "Store characteristics in retail oligopoly," RAND Journal of Economics, RAND Corporation, vol. 37(2), pages 416-430, 06.
  25. Patrick Bajari & Stephanie Houghton & Steve Tadelis, 2006. "Bidding for Incomplete Contracts: An Empirical Analysis," NBER Working Papers 12051, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. 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.
  2. 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.
  3. Lach, Saul & Moraga-González, José-Luis, 2009. "Asymmetric Price Effects of Competition," CEPR Discussion Papers 7319, C.E.P.R. Discussion Papers.
  4. 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.
  5. 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.
  6. Ian M. McCarthy & Rusty Tchernis, 2010. "Search costs and Medicare plan choice," Health Economics, John Wiley & Sons, Ltd., vol. 19(10), pages 1142-1165.
  7. Rauh, Michael T., 2009. "Strategic complementarities and search market equilibrium," Games and Economic Behavior, Elsevier, vol. 66(2), pages 959-978, July.
  8. 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.
  9. Saul Lach & Jose Luis Moraga-Gonzalez, 2009. "Asymmetric Price Effects of Competition," Tinbergen Institute Discussion Papers 09-049/2, Tinbergen Institute.
  10. Giacomo Pasini & Paolo Pin & Simon Weidenholzer, 2008. "A Network Model of Price Dispersion," Working Papers 2008.28, Fondazione Eni Enrico Mattei.

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