Nonparametric Estimation of Search Costs for Differentiated Products: Evidence from Medigap

Abstract

This article develops a method to estimate search frictions as well as preference parameters in differentiated product markets. Search costs are nonparametrically identified, which means our method can be used to estimate search costs in differentiated product markets that lack a suitable search cost shifter. We apply our model to the U.S. Medigap insurance market. We find that search costs are substantial: the estimated median cost of searching for an insurer is $30. Using the estimated parameters we find that eliminating search costs could result in price decreases of as much as $71 (or 4.7%), along with increases in average consumer welfare of up to $374.

Key Words:

• Consumer search; Health insurance; Price dispersion; Product differentiation

ACKNOWLEDGMENTS

We are grateful to the Editor, an Associate Editor, and two anonymous referees for their very useful comments and suggestions. In addition, we thank Mike Baye, Kate Bundorf, Andrew Ching, Leemore Dafny, David Dranove, Hanming Fang, Marty Gaynor, Lorens Helmchen, Claudio Lucarelli, Nicole Maestas, Jeff Prince, Jon Skinner, Kosali Simon, Alan Sorensen, and participants at various seminars and conferences for helpful comments and suggestions. This article was previously circulated under the title “Search and Prices in the Medigap Insurance Market.”