Search Frictions and Market Power in Negotiated Price Markets

Abstract

This paper develops and estimates a search and bargaining model designed to measure the welfare loss associated with frictions in oligopoly markets with negotiated prices. We use the model to quantify the consumer surplus loss induced by the presence of search frictions in the Canadian mortgage market, and evaluate the relative importance of market power, inefficient allocation, and direct search costs in explaining the loss. Our results suggest that search frictions reduce consumer surplus by almost $20 per month on a $100,000 loan, and that 17% of this reduction can be associated with discrimination, 30% with inefficient matching, and the remainder with the search cost. In addition, we find that product differentiation attenuates the effect of search frictions by reducing the cost of gathering quotes and improving efficiency, while posted prices do so through the ability of the first-mover to price discriminate. In contrast, competition amplifies the welfare effect of search frictions. Despite this, the overall effect of competition is to increase aggregate consumer surplus and drive prices down, but these effects are not spread equally across consumers: those with low search costs benefit more from competition.

Keywords: Financial institutions, financial services, market structure and pricing

JEL Classification: G21, L22, D4