Sponsored Search

I develop a theory of digital marketplaces where an intermediary provides a platform for firms to advertise their product and where consumers need to engage in costly search if they want to learn more about the products. First, I show that when prices are observable prior to search, a more prominent firm charges a higher price and earns higher revenue. Second, I augment this model by allowing the intermediary to determine endogenously the order in which products are displayed and the advertising commissions (per-click) to be paid, through an auction. I show that the pass-through from these commissions to product prices is higher for a non-prominent firm, thus restricting its ability to compete using price. This asymmetry in equilibrium lowers competition, consumer surplus and total transactions in the product market