Consumer Search and Its Implications for Market Competitions

Abstract

This dissertation covers three essays in modelling the market competitions with the presence of consumer search. The first two essays add on Wolinsky's (1986) model to investigate firms' optimal choice of their way of doing business in response to the changing consumer search behaviors during the information age. The third essay modifies the Varian's (1980) model to provide a new mechanism to rationalize the countercyclical markups in supermarkets. The first essay concerns the formation of referral alliance. It extends the Wolinsky's (1986) model to a three-stage game with two types of products produced by a continuum of firms with each one having strength in a single type only. In the first stage, firms simultaneously decide on the formation of referral alliances, in which each alliance consists of a pair of firms producing different types of products. In the second stage, they set price simultaneously. In the third stage, each consumer who only values one type of product searches sequentially for the right product. We show that firms with low ability to deal with the unmatched consumers are positively assorted together in the formation of referral alliance with multiple equilibrium possible. The proliferation of referral alliance always benefits consumers but not necessarily firms. One the one hand, it intensifies competition and drives down the market price. On the other hand, it increases the mass of consumers participating in the search market. The price elasticity of demand together with our stability condition govern the changes in consumer and social welfare as the search cost varies. The reduction in search cost always increases consumer and social welfare only if the equilibrium is stable with elastic demand. The policy implication from our results is that it might be more effective to improve consumer and social welfare by inducing more firms to participate in the referral alliances rather than reducing the consumers' search cost. The second essay studies the incentives for stores to invest effort in serving customers if effort is costly and might be merely persuasive that reduces consumption utility. We incorporate a sales agent to each store in Wolinsky's (1986) model, in which the sales agent is paid either by fixed wage or by commissions. The commissions motivate sales agents to provide more advice, which could be indeed useful to increase clients' willingness to pay or merely persuasive without affecting it. Consumers are sophisticated that understand the dual roles of effort before visiting firms, but they might be impressionable and therefore could not stay away from the effect of persuasion when they are making the purchasing decision. When consumers are heterogeneous in terms of their impressionability, they are sorted into stores with fixed wage and commissions in the equilibrium. The composition of stores varies with the search cost and the ability of sales agents to increase consumers' willingness to pay (effectiveness of advice). When the advice is relatively ineffective, there will be an increase in mass of fixed wage stores in response to a reduction in search cost. The reverse is true when the advice is sufficiently effective. Additionally, the mass of fixed wage stores always increases as the advice becomes less effective. The competitive equilibrium outcome might imply that there are too little commission-based stores, so it could be social welfare enhancing by encouraging more consumers to visit the stores with commissions. The third essay provides a simple mechanism that rationalizes the countercyclical markups in supermarkets with the presence of a warehouse club. We first provide a mechanism on the higher supermarket prices upon the entry of the warehouse club. The new warehouse club attracts price-sensitive consumers away from supermarkets, which reduces the price elasticity of the consumers in the supermarket regime. This relaxes price competition resulting in higher supermarket prices. After that we apply the same mechanism to explain the countercyclical markups in supermarkets. During economic booms, the time value of consumers increases making them less willing to visit the warehouse club. Thus, economic booms increase the amount of price-sensitive consumers in supermarkets, intensifying price competition and inducing a lower price relative to cost in booming times.