To understand the effect of R&Rs on the distribution of prices for child care centers, we develop a model of search for a market with vertical differentiation. Reflecting the stylized facts of child care markets, consumers are imperfectly informed about both prices and product quality in our base model. We determine equilibrium prices and determine the average price, the maximum price and the dispersion of prices for this model. For comparison purposes, we also derive expressions for the average price, the maximum price and the dispersion of prices when parents are fully informed about both prices and the quality of available products. To determine the effect of information on prices, we compare the distribution of equilibrium prices when information is imperfect with the distribution of prices when parents are fully informed. We show conditions under which better information reduces price dispersion, maximum price, and average price.
To develop a model that reflects important aspects of the child care market, we draw upon the theoretical literature on the effects of information on market outcomes (Reinganum (1979), Butters (1979), Rob (1985), Schwartz and Wilde (1985), Chan and Leland (1986), Diamond (1987), Benabou (1988) and Stiglitz (1989)) and the literature on quality differentiation in monopolistically competitive markets (Gabszewicz and Thisse (1979), Shaked and Sutton (1982), and Ronnen (1991)). As is standard in the literature, we focus on the effect of information on the average price, maximum price and the dispersion of prices. We assume that consumers search over price and quality and that markets are monopolistically competitive.
We adopt the basic features of models commonly used to study quality’ differentiation in monopolistically competitive markets. The supply side of the market consists of two firms producing quality-differentiated goods and engaging in price competition. As in Gabszewicz and Thisse (1979), we assume that each firm offers exactly one exogenously chosen quality level, with qL < qH. Firms face the same quality-dependent cost of production. The low quality firm has marginal cost cL and the high quality firm has marginal cost сH , where cL < cH .