The Determinants and Consequences of Search Cost Heterogeneity: Evidence from Local Gasoline Markets

Abstract

Information frictions play a key role in an array of economic activities and are frequently incorporated into formal models as search costs. However, little is known about the underlying source of consumer search costs and how heterogeneous they are across consumers and markets. This paper documents the sources and magnitude of heterogeneity in consumer search costs and analyzes how the heterogeneity shapes firms' pricing and consumers' search behavior. By identifying hundreds of geographically isolated markets, we are the first to estimate the distribution of consumer search costs for many geographic markets. We directly recover the distribution of consumer search costs market by market using retail gasoline price data in the United States. We find that the distribution of consumer search costs varies significantly across geographic markets and that the distribution of household income is closely associated with the search cost distribution. We find that a policy that reduces both the standard deviation and mean of the search cost distribution has heterogeneous and potentially unintended consequences on prices across markets.

Keywords: Search Costs; Consumer Search; Price Dispersion; Pricing; Consideration Set Formation; Retail Gasoline

JEL Classification: D4, D8, L8