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Search Costs and Risky Investment in Quality

Author

Listed:
  • Arthur Fishman

    () (Bar-Ilan University)

  • Nadav Levy

    (IDC Herzliya)

Abstract

One striking development associated with the explosion of e-commerce is the increased transparency of sellers' quality history. In this paper we analyze how this affects fi rms' incentives to invest in quality when the outcome of investment is uncertain. We identify two conflicting effects. On the one hand, reducing the consumer's cost of search for quality exacerbates the negative effects of past poor performance. This increases incentives to invest, leading to higher quality. On the other hand, the fact that a fi rm, despite its best efforts, may fail to live up to consumers' more demanding expectations, makes investment less attractive. This discourages investment, leading to lower quality. We show that reducing the search cost leads to higher quality if the initial level of the search cost is sufficiently high but may lead to lower quality if the initial level of the search cost is sufficiently low.

Suggested Citation

  • Arthur Fishman & Nadav Levy, 2011. "Search Costs and Risky Investment in Quality," Working Papers 2011-04, Bar-Ilan University, Department of Economics.
  • Handle: RePEc:biu:wpaper:2011-04
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    File URL: http://www.biu.ac.il/soc/ec/wp/2011-04.pdf
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    References listed on IDEAS

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    3. Avichai Snir & Daniel Levy, 2011. "Shrinking Goods and Sticky Prices: Theory and Evidence," Working Papers 2011-03, Bar-Ilan University, Department of Economics.
    4. Ronen Bar-El & Teresa García-Muñoz & Shoshana Neuman & Yossef Tobol, 2013. "The evolution of secularization: cultural transmission, religion and fertility—theory, simulations and evidence," Journal of Population Economics, Springer;European Society for Population Economics, vol. 26(3), pages 1129-1174, July.
    5. Andrew T. Young & Matthew J. Higgins & Daniel Levy, 2008. "Sigma Convergence versus Beta Convergence: Evidence from U.S. County-Level Data," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(5), pages 1083-1093, August.
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    Cited by:

    1. Itai Ater & Eugene Orlov, 2013. "The Effect of the Internet on Performance and Quality: Evidence from the Airline Industry," Working Papers 13-07, NET Institute.
    2. Mariana Cunha & António Osório & Ricardo Ribeiro, 2016. "Endogenous product design and quality with rationally inattentive consumers," Working Papers de Economia (Economics Working Papers) 03, Católica Porto Business School, Universidade Católica Portuguesa.

    More about this item

    Keywords

    search; internet search; quality; risky investment;

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

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