Persuasion Produces the (Diamond) Paradox

TL;DR

This paper extends a search model to show that persuasion can lead to no active consumer search, resulting in monopoly profits or marginal cost pricing, thus explaining the Diamond paradox.

Contribution

It introduces a model where firms choose information disclosure levels, demonstrating how persuasion sustains the Diamond paradox with no active search equilibria.

Findings

No active search equilibria exist with persuasion.

Firms price at marginal cost in equilibrium.

Consumers obtain zero surplus in equilibrium.

Abstract

This paper extends the sequential search model of Wolinsky (1986) by allowing firms to choose how much match value information to disclose to visiting consumers. This restores the Diamond paradox (Diamond 1971): there exist no symmetric equilibria in which consumers engage in active search, so consumers obtain zero surplus and firms obtain monopoly profits. Modifying the scenario to one in which prices are advertised, we discover that the no-active-search result persists, although the resulting symmetric equilibria are ones in which firms price at marginal cost.