Consumer search with observational learning

Author(s)

Daniel Garcia, Sandro Shelegia

Abstract

This paper studies observational learning in a consumer search environment.
In our model, consumers observe the purchasing decision of a predecessor
before deciding which firm to visit. We show that if consumers emulate
their predecessor and initiate their search at the firm she purchased from, a
social multiplier of demand induces a lower equilibrium price. Further, as the
search cost increases, firms compete fiercely to attract consumers and prices
converge to the marginal cost. We show that the result can be extended to any
number of firms, and the effect of emulation on prices is stronger as the number
of firms increases. We also show that, as consumers observe more previous
purchasing decisions, the downward pressure on prices grows to the degree
that the pure strategy equilibrium may cease to exist. We then provide a rationale
for emulation by introducing positive correlation in preferences across
consumers. This correlation gives rise to free-riding which deters search, and
as a result puts further downward pressure on prices for high search cost.

Organisation(s)

Department of Economics

No. of pages

45

Publication date

01-2015

Austrian Fields of Science 2012

502047 Economic theory

Keywords

Portal url

https://ucris.univie.ac.at/portal/en/publications/consumer-search-with-observational-learning(f185ed6e-3dda-4d03-b13e-10bf0d3a4855).html