NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

How the Internet Lowers Prices: Evidence from Matched Survey and Auto Transaction Data

Florian Zettelmeyer, Fiona Scott Morton, Jorge Silva-Risso

NBER Working Paper No. 11515
Issued in August 2005
NBER Program(s):   IO

There is convincing evidence that the Internet has lowered the prices paid by some consumers in

established industries, for example, term life insurance and car retailing. However, current research

does not reveal much about how using the Internet lowers prices. This paper answers this question

for the auto retailing industry. We use direct measures of search behavior and consumer

characteristics to investigate how the Internet affects negotiated prices. We show that the Internet

lowers prices for two distinct reasons. First, the Internet helps consumers learn the invoice price of

dealers. Second, the referral process of online buying services, a novel institution made possible by

the Internet, also helps consumers obtain lower prices. The combined information and referral price

effects are -1.5%, corresponding to 22% of dealers' average gross profit margin per vehicle. We also

find that buyers with a high disutility of bargaining benefit from information on the specific car they

eventually purchased while buyers who like the bargaining process do not. The results suggest that

the decisions consumers make to use the Internet to gather information and to use the negotiating

clout of an online buying service have a real effect on the prices paid by these consumers.

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