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Search costs are a facet of
transaction cost In economics and related disciplines, a transaction cost is a cost in making any economic trade when participating in a market. Oliver E. Williamson defines transaction costs as the costs of running an economic system of companies, and unlike produ ...
s or
switching costs Switching costs or switching barriers are terms used in microeconomics, strategic management, and marketing. They may be defined as the disadvantages or expenses consumers feel they experience, along with the economic and psychological costs of swit ...
and include all the costs associated with the searching activity conducted by a prospective seller and buyer in a market.
Rational Rationality is the quality of being guided by or based on reasons. In this regard, a person acts rationally if they have a good reason for what they do or a belief is rational if it is based on strong evidence. This quality can apply to an abili ...
consumers will continue to search for a better product or service until the
marginal cost In economics, the marginal cost is the change in the total cost that arises when the quantity produced is incremented, the cost of producing additional quantity. In some contexts, it refers to an increment of one unit of output, and in others it r ...
of searching exceeds the
marginal benefit In economics, utility is the satisfaction or benefit derived by consuming a product. The marginal utility of a good or service describes how much pleasure or satisfaction is gained by consumers as a result of the increase or decrease in consumpti ...
.
Search theory In microeconomics, search theory studies buyers or sellers who cannot instantly find a trading partner, and must therefore search for a partner prior to transacting. Search theory clarifies how buyers and sellers choose when to acknowledge a coo ...
is a branch of
microeconomics Microeconomics is a branch of mainstream economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. Microeconomics fo ...
that studies decisions of this type. The costs of searching are divided into external and internal costs. External costs include the monetary costs of acquiring the information, and the
opportunity cost In microeconomic theory, the opportunity cost of a particular activity is the value or benefit given up by engaging in that activity, relative to engaging in an alternative activity. More effective it means if you chose one activity (for example ...
of the time taken up in searching. External costs are not under the consumer's control, and all he or she can do is choose whether or not to incur them. Internal costs include the mental effort given over to undertaking the search, sorting the incoming information, and integrating it with what the consumer already knows. Internal costs are determined by the consumer's ability to undertake the search, and this in turn depends on intelligence, prior knowledge, education and training. These internal costs are the background to the study of
bounded rationality Bounded rationality is the idea that rationality is limited when individuals make decisions, and under these limitations, rational individuals will select a decision that is satisfactory rather than optimal. Limitations include the difficulty of ...
. There is an optimal value for search cost. A moderate amount of information maximises the likelihood of a purchase. Too much information to consumers may lead to negative effect. Too little information may not be enough to support consumers' purchasing decisions.


Search Cost Models

Numerous search cost models exist to depict the process of
consumer A consumer is a person or a group who intends to order, or uses purchased goods, products, or services primarily for personal, social, family, household and similar needs, who is not directly related to entrepreneurial or business activities. T ...
s searching for alternative
goods In economics, goods are items that satisfy human wants and provide utility, for example, to a consumer making a purchase of a satisfying product. A common distinction is made between goods which are transferable, and services, which are not tran ...
and
service Service may refer to: Activities * Administrative service, a required part of the workload of university faculty * Civil service, the body of employees of a government * Community service, volunteer service for the benefit of a community or a pu ...
s.


Basic Price Search Model

The most basic search cost model serves as a foundation for subsequent models. Peter A. Diamond's Model of Price Adjustment illustrates that small search frictions have an important role in
market structure Market structure, in economics, depicts how firms are differentiated and categorised based on the types of goods they sell (homogeneous/heterogeneous) and how their operations are affected by external factors and elements. Market structure makes it ...
, and a firm's capacity to deviate from
Bertrand Competition Bertrand competition is a model of competition used in economics, named after Joseph Louis François Bertrand (1822–1900). It describes interactions among firms (sellers) that set prices and their customers (buyers) that choose quantities at the p ...
. ''Proposition of the model:'' A unique
nash equilibrium In game theory, the Nash equilibrium, named after the mathematician John Nash, is the most common way to define the solution of a non-cooperative game involving two or more players. In a Nash equilibrium, each player is assumed to know the equili ...
is: p_1^* = p_2^* = ... = p_n^* = p^m , where, s =
Cost In production, research, retail, and accounting, a cost is the value of money that has been used up to produce something or deliver a service, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which ...
of obtaining price at quote with 0, CS =
Consumer surplus In mainstream economics, economic surplus, also known as total welfare or total social welfare or Marshallian surplus (after Alfred Marshall), is either of two related quantities: * Consumer surplus, or consumers' surplus, is the monetary gain ...
and p =
Price A price is the (usually not negative) quantity of payment or compensation given by one party to another in return for goods or services. In some situations, the price of production has a different name. If the product is a "good" in the c ...
. The model implies that search frictions can result in the perfectly competitive market price shifting to the
monopoly A monopoly (from Greek language, Greek el, μόνος, mónos, single, alone, label=none and el, πωλεῖν, pōleîn, to sell, label=none), as described by Irving Fisher, is a market with the "absence of competition", creating a situati ...
price. However, Diamond's original model is rudimentary and ignores some
empirical Empirical evidence for a proposition is evidence, i.e. what supports or counters this proposition, that is constituted by or accessible to sense experience or experimental procedure. Empirical evidence is of central importance to the sciences and ...
observations: # Agents in an
economy An economy is an area of the production, distribution and trade, as well as consumption of goods and services. In general, it is defined as a social domain that emphasize the practices, discourses, and material expressions associated with the ...
only search once, whereas there is a continuous search for goods and services. # Few consumers search in equilibrium, which is inconsistent with empirical observation. # The model uses an alternative to the “
law of one price The law of one price (LOOP) states that in the absence of trade frictions (such as transport costs and tariffs), and under conditions of free competition and price flexibility (where no individual sellers or buyers have power to manipulate prices ...
”. The
monopoly price A monopoly price is set by a monopoly.Roger LeRoy Miller, ''Intermediate Microeconomics Theory Issues Applications, Third Edition'', New York: McGraw-Hill, Inc, 1982.Tirole, Jean, "The Theory of Industrial Organization", Cambridge, Massachusetts: Th ...
is used as opposed to
marginal cost In economics, the marginal cost is the change in the total cost that arises when the quantity produced is incremented, the cost of producing additional quantity. In some contexts, it refers to an increment of one unit of output, and in others it r ...
, with no consideration for
price dispersion In economics, price dispersion is variation in prices across sellers of the same item, holding fixed the item's characteristics. Price dispersion can be viewed as a measure of trading frictions (or, tautologically, as a violation of the law of one ...
in an equilibrium.


Heterogenous Search Model

Using Diamond's model as a base, a distinction is now made in the heterogenous search model. There are potential consumer heterogeneities for search costs being consistent with market observations (search costs can be 0 and negative). In 1989, Ingemar Stahl expanded on Diamond's model; the model has the same assumptions as Diamond's model with the additions of ‘shoppers’ (μ) having a range of search costs (- ve : + ve). Stahl's model addresses the three issues present in Diamond's basic price search model. Firstly, this model assumes that search costs are changing as ‘shoppers’ search costs change. Secondly, all searches are now assumed to be done in equilibrium with different qualities of searches being conducted by different consumers (refers to the changing fraction of ‘shopper’ and their changing search costs, as consumers search at different times). Finally, the model achieves price dispersion, which is consistent with empirical market observations.


Examples of Search Costs


Fuel Shortages

During the early and late 70s, The Organisation of Arab Petroleum Exporting Countries, or OAPEC, stopped all its exports to the US, South Africa, Portugal, and the Netherlands due to their support of Israel in the
Yom Kippur War The Yom Kippur War, also known as the Ramadan War, the October War, the 1973 Arab–Israeli War, or the Fourth Arab–Israeli War, was an armed conflict fought from October 6 to 25, 1973 between Israel and a coalition of Arab states led by Egy ...
. Before the sanctions were imposed, the United States was receiving on average two thirds of its oil from OAPEC countries. This caused a big shortage of fuel. Motorists and business owners started having to spend more and more time looking for service stations with fuel in stock. Once a station was found motorists then had to wait in queues, sometimes as long as five miles, in order to fill up. In some areas odd-even rationing was even instated. This meant that on odd numbered days only vehicles with odd numbers as the last digit on their number plate would be allowed to buy fuel and vice versa for even numbers. Activities such as searching for fuel (the product) over time is called intertemporal search behaviour and is often associated with cross-sectional search behaviour. Motorists comparing fuel prices at different service stations at a given point in time is an example of cross-sectional search behaviour. These search behaviours result in a search cost to the consumer through the disutility gained in lost time. During stages of fuel shortages, such as those mentioned above, there is an overall increase in these search behaviours and thus an increase in search costs. Increasing search costs decreases the
price elasticity of demand A good's price elasticity of demand (E_d, PED) is a measure of how sensitive the quantity demanded is to its price. When the price rises, quantity demanded falls for almost any good, but it falls more for some than for others. The price elastici ...
and thus suppliers increase prices.


Labour Markets

Job seeking activities such as finding vacant positions, gathering information about a firm, preparing a
résumé A résumé, sometimes spelled resume (or alternatively resumé), also called a curriculum vitae (CV), is a document created and used by a person to present their background, skills, and accomplishments. Résumés can be used for a variety of re ...
and
cover letter A cover letter, covering letter, motivation letter, motivational letter, or a letter of motivation is a letter of introduction attached to or accompanying another document such as a résumé or a curriculum vitae. For employment Job seekers f ...
, preparing for an interview, and travelling to and from the job interview are examples of activities that incur a search cost from the individual. The larger this search cost is the more likely the chance that a worker will exit the market before initiating a search for a job. This is brought about by a combination of the low probability of finding a permanent job, as low as 19% in some studies/areas, and a low level of current capital. These factors also often cause agents to cease their searching activities after a number of failed attempts, even when the worker has cash on hand that covers the search costs multiple times. To maintain saving in excess of this minimum threshold value, the worker participates in
temporary employment Temporary work or temporary employment (also called gigs) refers to an employment situation where the working arrangement is limited to a certain period of time based on the needs of the employing organization. Temporary employees are sometimes ...
while conducting their search. This increases the staff turnover of the these companies. With increased technological integration of the advertisement and management of job opportunities as well as worker information and the provision of accessible and affordable
public transport Public transport (also known as public transportation, public transit, mass transit, or simply transit) is a system of transport for passengers by group travel systems available for use by the general public unlike private transport, typical ...
these effects can be treated.


Technology and Search Costs

With the rise in popularity and sophistication of computers and other
electronic devices The field of electronics is a branch of physics and electrical engineering that deals with the emission, behaviour and effects of electrons using Electronic component, electronic devices. Electronics uses Passivity (engineering), active devices ...
, the
Internet The Internet (or internet) is the global system of interconnected computer networks that uses the Internet protocol suite (TCP/IP) to communicate between networks and devices. It is a '' network of networks'' that consists of private, pub ...
was expected to eliminate search costs. For example,
electronic commerce E-commerce (electronic commerce) is the activity of electronically buying or selling of products on online services or over the Internet. E-commerce draws on technologies such as mobile commerce, electronic funds transfer, supply chain manageme ...
was predicted to cause
disintermediation Disintermediation is the removal of intermediaries in economics from a supply chain, or "cutting out the middlemen" in connection with a transaction or a series of transactions. Instead of going through traditional distribution channels, which h ...
as search costs become low enough for end-consumers to incur them directly instead of employing
retailers Retail is the sale of goods and services to consumers, in contrast to wholesaling, which is sale to business or institutional customers. A retailer purchases goods in large quantities from manufacturers, directly or through a wholesaler, and t ...
to do this for them. The reduction in marginal search costs of obtaining pricing information from electronic marketplaces through the implementation of the internet results in a downward pressure for the
price A price is the (usually not negative) quantity of payment or compensation given by one party to another in return for goods or services. In some situations, the price of production has a different name. If the product is a "good" in the c ...
of merchandise. Consumer's also have the ability to undertake comparisons of homogeneous products amongst competing electronic vendors, allowing them to purchase products which maximises their consumption
utility As a topic of economics, utility is used to model worth or value. Its usage has evolved significantly over time. The term was introduced initially as a measure of pleasure or happiness as part of the theory of utilitarianism by moral philosopher ...
. This is another factor contributing to the reduction in consumer search costs. The marginal search cost of obtaining quality information available to
consumers A consumer is a person or a group who intends to order, or uses purchased goods, products, or services primarily for personal, social, family, household and similar needs, who is not directly related to entrepreneurial or business activities. T ...
has conjunctionally decreased, resulting in a decrease in
price sensitivity A good's price elasticity of demand (E_d, PED) is a measure of how sensitive the quantity demanded is to its price. When the price rises, quantity demanded falls for almost any good, but it falls more for some than for others. The price elastici ...
. But using the Internet on a mobile phone can increase the cost of searching. The small screen size on a mobile phone can increase the cost of browsing information. For example, links that appear at the top of the screen are particularly likely to be clicked on the phone. That means ranking effects are higher on mobile phones suggesting higher search costs. Electronic marketplaces have hindered the ability of electronic merchants to implement
hidden costs In microeconomic theory, the opportunity cost of a particular activity is the value or benefit given up by engaging in that activity, relative to engaging in an alternative activity. More effective it means if you chose one activity (for exampl ...
such as transport and handling costs to obscure quoted prices. Commodity markets will evolve to display characteristics of the classical ideal of a Walrasian auctioneer as a result of electronic marketplaces as consumers have costless access to retailer pricing information and are fully informed. The competitive price taking equilibrium is a result of fully informed buyers as described within the classical market model. In oligopolistic markets, this equilibrium point represents Bertrand's zero profit equilibria. The effects of these Electronic marketplaces will translate to commodity markets by inciting price competition amongst retailers and shifting power to the consumers though the reduction in market power of the vendors. Interestingly, studies have found that user search behaviour, and thus search costs, differ significantly depending on which device they use to access electronic marketplaces.
Personal computer A personal computer (PC) is a multi-purpose microcomputer whose size, capabilities, and price make it feasible for individual use. Personal computers are intended to be operated directly by an end user, rather than by a computer expert or tec ...
(PC) users are much less sensitive to product rank. That is, they add more products to their evaluation pool before deciding on a product. This suggests that the cognitive effort it takes to process information, and thus the search costs, are much higher when users access the internet through their
mobile phone A mobile phone, cellular phone, cell phone, cellphone, handphone, hand phone or pocket phone, sometimes shortened to simply mobile, cell, or just phone, is a portable telephone that can make and receive calls over a radio frequency link whil ...
s. PC users are also more likely to choose a product that is geographically further away from their location than mobile phone users. These differences are mainly due to the smaller screen sizes in mobile phones and their ability to overcome the geographic and time sensitivity limitations of PC computers.


Obfuscation and Search Costs

Price
obfuscation Obfuscation is the obscuring of the intended meaning of communication by making the message difficult to understand, usually with confusing and ambiguous language. The obfuscation might be either unintentional or intentional (although intent u ...
is a strategy online retailers are implementing to derive further profits within electronic marketplaces and position themselves to regain market power. Obfuscation strategies within the classical search theory models represents consumers who are not fully informed simultaneously within the competitive a market through incremental increases in search costs, allowing firms to generate additional profits. Strategies include the development of products requiring additional purchases, or add-ons, which have large unadvertised mark ups. The use of a
loss-leader A loss leader (also leader) is a pricing strategy where a product is sold at a price below its market cost to stimulate other sales of more profitable goods or services. With this sales promotion/marketing strategy, a "leader" is any popular articl ...
approach is also implemented by online vendors to establish additional profits through the use of purposeful websites and advertisements designed to lure consumers into purchasing cheaper inferior goods and then to upgrade and purchase superior goods for higher prices. Customers are negatively affected by obfuscation because of the price increases and
direct costs Direct costs are costs which are directly accountable to a cost object (such as a particular project, facility, function or product). Direct cost is the nomenclature used in accounting. The equivalent nomenclature in economics is specific cost. By ...
it imposes on them. Although obfuscation is beneficial to firms, excessive obstruction of pricing information can lead to the collapse of a market. Interestingly, even firms who do not obfuscate their pricing benefit from the obfuscation conducted by other firms in the market. Since none of the consumers can compare prices, they still behave as if future search costs will be higher and thus the transparent company benefits.


See also

*
Analysis paralysis Analysis paralysis (or paralysis by analysis) describes an individual or group process where overanalyzing or overthinking a situation can cause forward motion or decision-making to become "paralyzed", meaning that no solution or course of acti ...
*
Satisficing Satisficing is a decision-making strategy or cognitive heuristic that entails searching through the available alternatives until an acceptability threshold is met. The term ''satisficing'', a portmanteau of ''satisfy'' and ''suffice'', was introduc ...
*
Search theory In microeconomics, search theory studies buyers or sellers who cannot instantly find a trading partner, and must therefore search for a partner prior to transacting. Search theory clarifies how buyers and sellers choose when to acknowledge a coo ...
*
Perfect Competition In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In Economic model, theoret ...
*
Price dispersion In economics, price dispersion is variation in prices across sellers of the same item, holding fixed the item's characteristics. Price dispersion can be viewed as a measure of trading frictions (or, tautologically, as a violation of the law of one ...
*
Cost In production, research, retail, and accounting, a cost is the value of money that has been used up to produce something or deliver a service, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which ...


References

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