Search cost

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Search costs are one facet of transaction costs or switching costs. Rational consumers will continue to search for a better product or service until the marginal cost of searching exceeds the marginal benefit. Search theory is a branch of microeconomics that studies decisions of this type.

The costs of searching are divided into external and internal costs.[1] External costs include the monetary costs of acquiring the information, and the opportunity cost of the time taken up in searching. External costs are not under the consumer's control, and all he or she can do is choose whether or not to incur them. Internal costs include the mental effort given over to undertaking the search, sorting the incoming information, and integrating it with what the consumer already knows. Internal costs are determined by the consumer's ability to undertake the search, and this in turn depends on intelligence, prior knowledge, education and training. These internal costs are the background to the study of bounded rationality.

The Internet was expected to eliminate search costs.[2] For example, electronic commerce was predicted to cause disintermediation as search costs become low enough for end-consumers to incur them directly instead of employing retailers to do this for them. The reduction in marginal search costs of obtaining pricing information from electronic marketplaces through the implementation of the internet results in a downward pressure for the price of merchandise.[3] Consumer's also have the ability to undertake comparisons of homogenous products amongst competing electronic vendors, allowing them to purchase products which maximizes their consumption utility.[4] This is another factor contributing to the reduction in consumer search costs. The marginal search cost of obtaining quality information available to consumers has conjunctionally decreased, resulting in a decrease in price sensitivity.[4]

Electronic marketplaces have hindered the ability of electronic merchants to implement hidden costs such as transport and handling costs to obscure quoted prices.[3] Commodity markets will evolve to display characteristics of the classical ideal of a Walrasian auctioneer as a result of electronic marketplaces as consumers have costless access to retailer pricing information and are fully informed. The competitive price taking equilibrium is a result of fully informed buyers as described within the classical market model. In oligopolistic markets, this equilibrium point represents Bertrand's zero profit equilibria.[4] The effects of these Electronic marketplaces will translate to commodity markets by inciting price competition amongst retailers and shifting power to the consumers though the reduction in market power of the vendors.[4]

Price obfuscation is a strategy online retailers are implementing to derive further profits within electronic marketplaces and position themselves to regain market power.[5] Obfuscation strategies within the classical search theory models represents consumers who are not fully informed simultaneously within the competitive a market through incremental increases in search costs, allowing firms to generate additional profits.[5] Strategies include the development of products requiring additional purchases, or add-ons, which have large unadvertised mark ups. The use of a loss-leader approach is also implemented by online vendors to establish additional profits through the use of purposeful website and advertisement design to lure consumers purchasing cheaper inferior goods to upgrade and purchase superior goods for higher prices.[5]

Search Cost Models[edit]

Numerous search cost models exist to depict the process of consumers searching for alternative goods and services.[6]

Born April 29th, 1940 New York City
Peter Arthur Diamond: Political, welfare and behavioural economics. Born April 29th, 1940, New York City

Basic Price Search Model[edit]

The most basic search cost model serves as a foundation for subsequent models. Peter A. Diamond's Model of Price Adjustment illustrates that small search frictions have an important role in market structure,[7] and a firm's capacity to deviate from Bertrand Competition.[8]

Proposition of the model:

A unique nash equilibrium is: ,[8] where, s = Cost of obtaining price at quote with ,[8] CS = Consumer surplus and p = Price.

The model implies that search frictions can result in the perfectly competitive market price shifting to the monopoly price.[8] However, Diamond's original model is rudimentary and ignores some empirical observations: [7]

  1. Agents in an economy only search once, whereas there is a continuous search for goods and services.[7]
  2. Few consumers search in equilibrium, which is inconsistent with empirical observation.[7]
  3. The model uses an alternative to the “law of one price”. The monopoly price is used as opposed to marginal cost, with no consideration for price dispersion in an equilibrium.[7]

Heterogenous Search Model[edit]

Using Diamond's model as a base, a distinction is now made in the heterogenous search model. There are potential consumer heterogeneities for search costs being consistent with market observations (search costs can be 0 and negative).[8] In 1989, Ingemar Stahl expanded on Diamond's model; the model has the same assumptions as Diamond’s model with the additions of ‘shoppers’ (μ) having a range of search costs ().[8]

Stahl's model addresses the three issues present in Diamond's basic price search model . Firstly, this model assumes that search costs are changing as ‘shoppers’ search costs change.[8] Secondly, all searches are now assumed to be done in equilibrium with different qualities of searches being conducted by different consumers (refers to the changing fraction of ‘shopper’ and their changing search costs, as consumers search at different times).[8] Finally, the model achieves price dispersion, which is consistent with empirical market observations.[8]

See also[edit]

References[edit]

  1. ^ Smith, Gerald E; Venkatraman, Meera P; Dholakia, Ruby Roy (June 1999). "Diagnosing the search cost effect: Waiting time and the moderating impact of prior category knowledge". Journal of Economic Psychology. 20 (3): 285–314. doi:10.1016/S0167-4870(99)00010-0.
  2. ^ Pereira, Pedro (January 2005). "Do lower search costs reduce prices and price dispersion?". Information Economics and Policy. 17 (1): 61–72. doi:10.1016/j.infoecopol.2004.03.001.
  3. ^ a b Bakos, Yannis (1997). "Reducing Buyer Search Costs: Implications for Electronic Marketplaces". Management Science. 43 (12): 1676–1692.
  4. ^ a b c d Lynch, John; Ariely, Dan (2000). "Wine Online: Search Costs Affect Competition on Price, Quality, and Distribution". Marketing science (Providence, R.I.). 19 (1): 83–103. doi:10.1287/mksc.19.1.83.15183.
  5. ^ a b c Ellison, Glenn; Ellison, Sara Fisher (2009). "Search, Obfuscation, and Price Elasticities on the Internet". Econometrica. 77 (2): 427–452. doi:10.3982/ECTA5708. ISSN 1468-0262.
  6. ^ "Finance and Development". Finance and Development | F&D. Retrieved 2021-04-25.
  7. ^ a b c d e "A model of price adjustment". Journal of Economic Theory. 3 (2): 156–168. 1971-06-01. doi:10.1016/0022-0531(71)90013-5. ISSN 0022-0531.
  8. ^ a b c d e f g h i Ellison, Sara Fisher. "Price search and obfuscation: an overview of the theory and empirics". Handbook on the Economics of Retailing and Distribution: 287–305. doi:10.4337/9781783477388.00022.