Working Paper: CEPR ID: DP7154
Authors: Gilles Saint-Paul
Abstract: The Internet plays a growing role in the economy. This paper extrapolates this trend and analyses a world where most transactions take place in "cyberspace". We ask the following question: how does the design of the search engine affect the incentives to innovate and the economy?s long run growth rate? This is done in the context of a "qualitative" model where growth occurs because the number of varieties grows and consumers select a shrinking fraction of the available goods, of growing quality. They must use a search engine to locate goods. The search engine affects the market size of a good over its life cycle, and thus the incentives to innovate. Its structure has two conflicting effects. A visibility effect by which a greater hit score increases market size. A selection effect by which consumers are more picky and select higher quality goods, thus reducing the life span of any given good.While these two effects on growth cancel out for simple specifications, that is no longer the case if a firm?s score is variable along its life cycle or if he search process uses resources. It is shown that the discount effect of gradual recognition of popularity tends to reduce growth. Hence, growth is enhanced if the search engine is less sensitive to popularity. Also, growth is lower when the search engine rewards "web page quality" better because of the resources diverted away from R and D into advertising. But these mechanisms generate opposite level effects on the average quality selected by consumers. As a result the net effect on welfare is ambiguous.
Keywords: advertising; endogenous growth; internet; quality ladders; R&D; search engines; selection
JEL Codes: O3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| search engine's visibility effect (D83) | market size (L25) |
| market size (L25) | innovation incentives (O31) |
| search engine's selection effect (C52) | consumer selectivity (L15) |
| consumer selectivity (L15) | lifespan of products (L15) |
| visibility effect (G14) | selection effect (C24) |
| search engine rewards web page quality (L15) | resources diverted from R&D to advertising (O32) |
| resources diverted from R&D to advertising (O32) | economic growth (O49) |
| visibility effect diminishes (F62) | net reduction in growth (O40) |
| visibility effect and selection effect can cancel each other out (G41) | ambiguous impact on growth (F69) |