Prices and Heterogeneous Search Costs

We study price formation in a model of consumer search for differentiated products when consumers have heterogeneous marginal search costs. We provide conditions under which a symmetric Nash equilibrium exists and is unique. Search costs affect two margins—the intensive search margin (or search intensity) and the extensive search margin (or the decision to search rather than to not search at all). These two margins affect the elasticity of demand in opposite directions and whether lower search costs result in higher or lower prices depends on the properties of the search cost density. When the search cost density has the increasing likelihood ratio property (ILRP), the effect of lowering search costs on the intensive search margin has a dominating influence and prices decrease. By contrast, when the search cost density has the decreasing likelihood ratio property (DLRP), the effect on the extensive search margin is dominant and lower search costs result in higher prices. We compare these results with those obtained when consumers have heterogeneous fixed search costs.