Information Gathering Externalities in Product Markets

Abstract

Goods and services vary along a number of dimensions independently. Customers can choose to acquire information to assess the quality of some dimensions and not others. Their choices affect firms’ incentives to invest in quality and so lead to indirect externalities in consumers’ choices. We illustrate these ideas in a simple model with a monopolist selling a product with two characteristics, investment in quality with stochastic realizations, and heterogeneous consumers. Consumers in choosing which information to acquire do not consider the effects on firm investment incentives and so there are indirect externalities in information gathering. Therefore, a fall in the cost of acquiring information, by changing the pattern of consumers’ information gathering and thereby firm investment, can paradoxically reduce consumer surplus, profits, and welfare. We briefly consider a number of potential extensions and in particular, highlight a benefit of diversity in tastes.