It is well known that the Internet has significantly reduced consumers'
search costs online. But relatively little is known about how search
costs affect consumer demand structure in online markets. In this paper,
we identify the impact of search costs on firm competition and market
structure by exploring a unique theoretical insight that search costs
create a kink in aggregate demand when firms change prices. The
significance of the kink reflects the magnitude of online search costs
and the kinked demand function provides information on how search costs
affect competition in the online market. Using a dataset collected from
Amazon and Barnes & Noble, we find that search costs vary
significantly across online retailers. Consumers face low search costs
for price information from Amazon.com. It leads to a higher price
elasticity when the firm reduces prices than when it increases prices,
increasing Amazon's incentive to engage in price competition. On the
other hand, consumers face relatively higher search costs for price
information from Barnes & Noble. This leads to a lower price
elasticity when Barnes & Noble reduces prices than when it increases
prices, reducing Barnes & Noble's incentive to engage in price
competition. We also find that search costs decrease with the passage of
time as the information about price changes dissipates among consumers,
leading to increased price elasticity over time. Finally, we highlight
that search costs are lower for popular books compared to rare and
unpopular books. These findings have implications for the impact of the
Internet on the Long Tail phenomenon
