Optimal Product Design: Implications for Competition and Growth under Declining Search Frictions

As search frictions become smaller in the market for a consumer product, buyers are able to locate and access more sellers per unit of time. In response, sellers choose to design varieties of the product that are more specialized in order to exploit differences in the buyers' preferences. I find mild conditions on the fundamentals under which the decline in search frictions and the increase in specialization have exactly offsetting effects on the extent of competition in the market. Under these conditions, price dispersion remains constant over time even though search frictions are vanishing. Buyer's surplus and seller's profit, however, grow at a constant endogenous rate, as the endogenous increase in specialization allows sellers to cater better and better to the heterogeneous desires of buyers.