APPLIED MICRO: Dr Ajay Shenoy (University of California, Santa Cruz)

Demand-Driven Misallocation: The Upstream Impact of Search Frictions in Retail

Competitive markets allocate resources efficiently because buyers choose the most efficient producer, who can offer the lowest price. This demand-side pressure is dampened if search frictions prevent the retail sector from finding cheaper suppliers. We study the upstream misallocation created by frictions in retail search. We collect data from Lusaka, Zambia that links retailers, their suppliers, and their customers. Retailers persistently 1) pay different prices for identical goods, 2) bear different costs to search for suppliers, and 3) hold unduly pessimistic beliefs about the supplier price distribution. An RCT with two treatments, information about the true distribution versus price quotes from low-cost suppliers, disentangles the impact of inaccurate beliefs versus search costs. Both treatments increase supplier switching, reduce the price paid for inventory, and increase the accuracy of beliefs. We estimate a structural model where consumers search for retailers who in turn search for suppliers, all with heterogeneous search costs and beliefs. We validate the model by showing that it predicts the impact of the RCT. A counterfactual reduction in false beliefs would reduce misallocation by 15 percent, versus 3 percent for an equivalent reduction in search costs.