Search Costs and Risky Investment in Quality

25 Pages Posted: 31 Jan 2011 Last revised: 29 Jul 2013

Nadav Levy

Interdisciplinary Center (IDC) Herzliya

Arthur Fishman

Bar-Ilan University - Department of Economics

Date Written: January 1, 2012

Abstract

One striking development associated with the explosion of e-commerce is the increased transparency of sellers' quality. In this paper we analyze how this affects firms' incentives to invest in quality when the outcome of investment is uncertain. We identify two conflicting effects. On the one hand, reducing the consumer's cost of search for quality exacerbates the negative effects of delivering poor quality. On the other hand, the fact that a firm, despite its best efforts, may fail to live up to consumers' more demanding expectations, makes investment less attractive. We show that reducing the search cost leads to higher quality if the initial level of the search cost is sufficiently high but may lead to lower quality if the initial level of the search cost is sufficiently low.

Keywords: search, internet search, quality, investment in quality

JEL Classification: D83, L15

Suggested Citation

Levy, Nadav and Fishman, Arthur, Search Costs and Risky Investment in Quality (January 1, 2012). Available at SSRN: https://ssrn.com/abstract=1752066 or http://dx.doi.org/10.2139/ssrn.1752066

Nadav Levy (Contact Author)

Interdisciplinary Center (IDC) Herzliya ( email )

P.O. Box 167
Herzliya, 46150
Israel

Arthur Fishman

Bar-Ilan University - Department of Economics ( email )

Ramat-Gan, 52900
Israel
972-3-531-8366 (Phone)
972 3 535 3180 (Fax)

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