This paper compares the equilibrium outcomes in search markets with and without referrals. Although it seems clear that consumers would benefit from honest referrals, it is not at all clear whether firms would unilaterally provide information about competing offers since such information could encourage the consumer to purchase the product elsewhere. In a model of a horizontally differentiated product and sequential consumer search, we show that valuable referrals can arise in the equilibrium: a firm will give referrals to consumers whose ideal product is sufficiently far from the firm's offering. It is found that prices in the equilibrium are higher in markets with referrals. Although referrals can make consumers worse off, referrals lead to a Pareto improvement as long as the search cost is not too low relative to product heterogeneity. The effects of referral fees and third-party referrals are examined, and policy implications are drawn.
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Length: 44 pages Date of creation: 27 Jul 2005 Date of revision:
19 Jun 2008 Handle: RePEc:boc:bocoec:614
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Find related papers by JEL classification: C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory D4 - Microeconomics - - Market Structure and Pricing D8 - Microeconomics - - Information, Knowledge, and Uncertainty L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
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