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Referrals in Search Markets

  • Maria Arbatskaya
  • Hideo Konishi

This paper compares the equilibrium outcomes in search markets with and without referrals. Although it seems clear that consumers would benefit from referrals, it is not at all clear whether firms would unilaterally provide information about competing offers since such information could encourage consumers to purchase the product elsewhere. In a model of a horizontally differentiated product and sequential consumer search, we show that valuable referrals can arise in the equilibrium: a firm will give referrals to consumers whose ideal product is sufficiently far from the firm's offering. It is found that the equilibrium prices are higher in markets with referrals. Although referrals can make consumers worse off, referrals lead to a Pareto improvement as long as the search cost is not too low relative to product heterogeneity. Similar results are obtained in the presence of referral fees and in the case where firms can price-discriminate among consumers and consumers can misrepresent their tastes.

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Paper provided by Department of Economics, Emory University (Atlanta) in its series Emory Economics with number 1004.

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Date of creation: Jul 2010
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Handle: RePEc:emo:wp2003:1004
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  1. Birger Wernerfelt, 1994. "Selling Formats for Search Goods," Marketing Science, INFORMS, vol. 13(3), pages 298-309.
  2. Colwell, Peter F & Kahn, Charles M, 2001. "The Economic Functions of Referrals and Referral Fees," The Journal of Real Estate Finance and Economics, Springer, vol. 23(3), pages 267-96, November.
  3. Konishi, Hideo, 2005. "Concentration of competing retail stores," Journal of Urban Economics, Elsevier, vol. 58(3), pages 488-512, November.
  4. Anderson, Simon P & Renault, Regis, 2000. "Consumer Information and Firm Pricing: Negative Externalities from Improved Information," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 41(3), pages 721-42, August.
  5. Stiglitz, J E, 1979. "Equilibrium in Product Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 69(2), pages 339-45, May.
  6. Mark V. Pauly, 1979. "The Ethics and Economics of Kickbacks and Fee Splitting," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 344-352, Spring.
  7. Janssen, Maarten C.W. & Moraga-Gonzalez, Jose Luis & Wildenbeest, Matthijs R., 2005. "Truly costly sequential search and oligopolistic pricing," International Journal of Industrial Organization, Elsevier, vol. 23(5-6), pages 451-466, June.
  8. Asher Wolinsky, 1983. "Retail Trade Concentration Due to Consumers' Imperfect Information," Bell Journal of Economics, The RAND Corporation, vol. 14(1), pages 275-282, Spring.
  9. Wolinsky, Asher, 1984. "Product Differentiation with Imperfect Information," Review of Economic Studies, Wiley Blackwell, vol. 51(1), pages 53-61, January.
  10. 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.
  11. Stephen J. Spurr, 1990. "The Impact of Advertising and Other Factors on Referral Practices, with Special Reference to Lawyers," RAND Journal of Economics, The RAND Corporation, vol. 21(2), pages 235-246, Summer.
  12. Diamond, Peter A., 1971. "A model of price adjustment," Journal of Economic Theory, Elsevier, vol. 3(2), pages 156-168, June.
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