Consumer Search Costs and Market Performance

Laboratory markets are conducted to evaluate the effects of consumer search costs on market performance. The primary research goal is to assess the behavioral relevance of Diamond’s (1971) paradoxical conclusion that the injection of a small consumer search cost alters the equilibrium price prediction from competitive to monopoly levels. Although monopoly prices are not consistently observed, we find that search costs do tend to raise prices. Additional experimentation indicates that below-monopoly prices are not explained by sellers’ price-posting reputations, but that prices increase as search costs are raised. We conjecture that the Diamond prediction fails because sellers neither immediately appreciate, nor readily learn the necessary recursive "price-plus-search-cost" reasoning.