Is It More Profitable to Post Prices? – Market Structure with Endogenous Search Costs

Title of dissertation: IS IT MORE PROFITABLE TO POST PRICES? – MARKET STRUCTURE WITH ENDOGENOUS SEARCH COSTS Binglin Gong Doctor of Philosophy, 2006 Dissertation directed by: Professor John Rust Department of Economics This dissertation contains three chapters. It analyzes a market where firms can choose whether or not to publicly post their prices. Price posting rewards a firm by reducing search costs for customers and thus attracting more demand, at the risk of triggering more direct price competition. In the first two chapters, I use a continuous model and a discrete model to discuss possible market equilibria, respectively. In a non-cooperative and dynamic environment, I find that when the supporting information technology becomes available to all firms, a firm wants to post prices only when it has appropriate cost advantage over its competitors. A lower cost of posting prices encourages firms to post their prices. Price posting improves market efficiency unless one firm has too much cost advantage. When a more efficient entrant replaces the incumbent price-posting firm, the incumbent wants to hide its prices again. These results explain why in some markets firms or individual traders hesitate to publicly post their prices and some even impose search costs on their prices. In the third chapter, I use a laboratory experiment to show how a market evolves when firms or individual traders endogenously determine the search costs on their prices. In the experiment, human subjects play sellers and the computer calculates demands and profits, assuming consumers behave optimally. I assign costs and demand parameters to subjects and let them choose both their prices and whether or not to publicly post them. I alter the production costs, the fixed cost of posting prices, and the possibility of communication among subjects across treatments to show the effect of these factors on market structure. Experimental results show that one is more likely to post prices when he or she has lower unit cost and when the fixed cost of posting prices becomes lower. Price posting lowers effective prices when communication among subjects is not allowed but raises prices when subjects can communicate with each other. IS IT MORE PROFITABLE TO POST PRICES? – MARKET STRUCTURE WITH ENDOGENOUS SEARCH COSTS