Entry and Welfare in Search Markets

The welfare effects of entry are studied in a model of consumer search. Potential entrants differ in quality, with high-quality sellers being more likely to meet consumer needs. Contrary to the standard view in economics that more entry benefits consumers, we find that free entry is excessive for both consumer welfare and total welfare when entry cost is relatively low, and consumer welfare has an inverted-U relationship with entry cost. We explain why these results may arise naturally in search markets due to the search variety and search quality effects of entry, and discuss their business and policy implications.