Diversity and Demand Externalities: How Cheap Information Can Reduce Welfare

14 Pages Posted: 25 Apr 2006

See all articles by Heski Bar-Isaac

Heski Bar-Isaac

University of Toronto - Rotman School of Management

Guillermo Caruana

Centre for Monetary and Financial Studies (CEMFI)

Vicente Cuñat

London School of Economics & Political Science (LSE) - Financial Markets Group

Multiple version iconThere are 2 versions of this paper

Date Written: April 4, 2006

Abstract

Goods and services vary along a number of dimensions independently. Customers can choose to acquire information on the quality of some dimensions and not others. Their choices affect firms' incentives to invest in quality and so lead to indirect externalities in consumers' choices. We illustrate these ideas in a simple model with a monopolist selling a product with two characteristics, investments in quality with stochastic realizations and heterogeneous consumers. A fall in the cost of acquiring information on the quality of one characteristic leads more consumers to verify that characteristic. Consequently, the firm may under-provide quality on the other. This may paradoxically reduce consumer surplus, profits and welfare. Our discussion concludes with a number of potential extensions and applications of the basic framework.

Suggested Citation

Bar-Isaac, Heski and Caruana, Guillermo and Cuñat, Vicente, Diversity and Demand Externalities: How Cheap Information Can Reduce Welfare (April 4, 2006). Available at SSRN: https://ssrn.com/abstract=898005 or http://dx.doi.org/10.2139/ssrn.898005

Heski Bar-Isaac (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
416 978 3626 (Phone)

HOME PAGE: http://https://sites.google.com/site/heskibarisaac/home

Guillermo Caruana

Centre for Monetary and Financial Studies (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
34 91 429 0551 (Phone)
34 91 429 1056 (Fax)

Vicente Cuñat

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom

HOME PAGE: http://www.vicentecunat.com

Register to save articles to
your library

Register

Paper statistics

Downloads
46
Abstract Views
645
PlumX Metrics