TILEC Work In Progress: Peerawant Samranchit

Abstract:

This paper analyzes how inaccurate recommendations received by consumers affect price competition between sellers who sell horizontally differentiated products. I extend Salop's circular model by introducing an element of consumer search. A consumer will decide to search if the recommendation he received is far away from his preferred variety, or the price of the recommended seller is too high. The paper shows that an improvement in the accuracy of the recommendations – more consumers see recommended products closer to their preferred varieties – may have a non-monotonic relationship with the equilibrium price. When the consumer's search cost is low, an improvement in the accuracy initially decreases the price before it starts to increase after the accuracy keeps improving.