Measuring the effects of search costs on equilibrium prices and profits

This paper assesses the effects of search costs on equilibrium prices and profits. Using an estimated model of demand and costs in a laundry detergent market, I find that some firms’ profits initially rise and then fall with search costs. Overall, the magnitude and direction of the search costs’ effects on prices and profits are heterogeneous. This is because search costs create conflicting incentives for a firm to reduce prices to attract the attention of searching consumers, yet also raise prices to harvest profit from consumers who are unaware of competing products. These effects can vary with the relationship between the firms’ actual prices and the consumers’ pre-search beliefs about prices.