Working Paper: NBER ID: w29618
Authors: James Albrecht; Guido Menzio; Susan Vroman
Abstract: We consider a version of the imperfect competition model of Butters (1977), Varian (1980) and Burdett and Judd (1983) in which sellers make an ex-ante investment in the quality of their variety of the product. Equilibrium exists, is unique and is efficient. In equilibrium, search frictions not only cause sellers to offer different surpluses to buyers but also cause sellers to choose different qualities for their varieties. That is, equilibrium involves endogenous vertical differentiation. As search frictions decline, the market becomes more and more unequal as a smaller and smaller fraction of sellers produces varieties of increasing quality, offers increasing surplus to their customers, and captures an increasing share of the market, while a growing fraction of sellers produces varieties of decreasing quality. Gains from trade and welfare grow. Under some conditions, the growth rate of gains from trade and welfare is constant.
Keywords: search frictions; vertical differentiation; market concentration; gains from trade; welfare
JEL Codes: D43; D83; L13; O40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| search frictions (F12) | seller quality (L15) |
| seller quality (L15) | surplus offered (D46) |
| search frictions (F12) | market concentration (L11) |
| search frictions (F12) | total gains from trade (F11) |
| search frictions (F12) | overall welfare (I31) |
| decline in search frictions (D83) | quality polarization (C46) |
| quality polarization (C46) | revenue concentration (D30) |
| declining search frictions (D83) | seller welfare (D69) |