Heterogeneous Search Costs in a Market with Hidden Fees

This paper models a market in which one firm sells a good with a public base price and a hidden additional fee. Consumers are separated by high and low search costs and have the opportunity to incur their search cost to learn the true value of the add-on price. The firm has a discontinuous profit function that models its trade off between increasing the base price and losing consumers who drop out of the market. Results show that in a market with many low cost consumers, the firm has an incentive to charge a lower base price than it does in a market with many high cost consumers. This lower base price also leads to positive consumer welfare for both high and low cost consumers.