Abstract: In a seminal paper, Champsaur and Rochet (1989) showed that competing firms choose non-overlapping qualities so as to soften price competition at the cost of giving up profitable opportunities to price discriminate. In this paper we show that an arbitrarily small amount of search frictions is enough to give rise to an equilibrium with overlapping qualities. This is in contrast to other sources of market power (e.g. horizontal product differentiation), which have to be sufficiently strong in order to give rise to overlapping qualities. In markets with search frictions, competing firms face the monopolist’s incentive to price discriminate, which induces them to offer the full product line even if this forces them to compete head-tohead. Hence, search frictions increase prices and reduce consumers surplus for given product choices, but they can also lead to lower prices and higher consumer surplus whenever they induce firms to offer broader and overlapping quality offerings.
Keywords: second degree price discrimination, search, vertical differentiation, retail competition.