Posted by Kathryn Schwartz on June 27, 2014

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The market for child care is characterized by vertical differentiation and asymmetric information between buyers and sellers, where buyers incur substantial search costs to learn about variations in prices and care characteristics. Such informational imperfections are common to many markets and have fundamental implications for how product markets function.

Despite the prevalence of informational imperfections, there is only limited understanding of the effects of information provision in vertically differentiated markets. The theoretical literature primarily considers the effects of information in markets with homogenous products. In vertically differentiated markets like child care and health services, there exists a distribution of product quality. The empirical literature considers the impact of information provision by advertisements. Advertising may affect equilibrium by providing information (informative advertising), but it may also engender brand loyalty.

In this paper, we study the effects of centralized information provision in a vertically differentiated market. We develop a model with features that reflect some important aspects of markets for child care and health services (e.g. product heterogeneity, search costs, and heterogeneous tastes for quality). We compare the functioning of such markets when there is imperfect information and when there is full information. We are able to show that the primary effect of information provision will be to decrease price dispersion. Information provision may also lower prices, but this requires strong willingness to search on the part of consumers who value product quality highly.

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