Matching, Pricing, and Quality Investment

We compare the efficiency of price posting and bargaining in a market with search frictions and signaling of goods quality.We focus on the tradeoff between two roles of each pricing mechanism: directing search and reducing asymmetric information. This tradeoff has largely been ignored in the literature. Models of directed search have abstracted from asymmetric information and, as result, they have concluded that price posting is more efficient than bargaining. In contrast, models with asymmetric information have shown that bargaining is more efficient than price posting if sellers have a sufficiently lower bargaining power. In those models, however, there is no role for directed search because each seller's matching probability is assumed to be independent of the pricing mechanism. To analyze the tradeoff between the two roles of a pricing mechanism, we consider a market in which each seller chooses an investment level that determines the quality of the goods, which is the seller's private information. Goods are "search goods" in the sense that the quality is revealed immediately to a buyer when the buyer visits the seller. Each seller can choose to bargain or to post a price, where posted price can also serve as a signal of quality. With bargaining, search is undirected and so the number of matches is inefficient. However, each seller's investment (and hence quality) is always efficient. In contrast, price posting as a way to direct search generates the efficient number of matches but, because signaling is costly to sellers, investment may not be efficient. We show that bargaining is more efficient than price posting if and only if asymmetric information is sufficiently severe and the seller's bargaining power is intermediate. Moreover, when sellers choose between the two mechanisms, the more efficient mechanism is the stable outcome of the market.