Entry and Welfare in Search Markets

Abstract

The effects of entry on consumer and total welfare are studied in a model of consumer search. Potential entrants differ in quality, with high-quality sellers being more likely to meet consumer needs. Contrary to the standard view in economics that more entry benefits consumers, we find that consumer welfare has an inverted-U relationship with entry cost, and free entry is excessive for both consumer and total welfare when entry cost is relatively low. We explain why these results may arise naturally in search markets due to the variety and quality effects of entry, and discuss their business and policy implications