Asymmetric Information and Overinvestment in Quality

37 Pages Posted: 20 Apr 2009

See all articles by Paul Belleflamme

Paul Belleflamme

CORE and Louvain School of Management, UCL (Université Catholique de Louvain); CESifo (Center for Economic Studies and Ifo Institute)

Martin Peitz

University of Mannheim - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: April 2009

Abstract

In a standard adverse selection world, asymmetric information about product quality leads to quality deterioration in the market. Suppose that a higher investment level makes the realization of high quality more likely. Then, if consumers observe the investment (but not the realization of product quality) before purchase, they can infer the probability distribution of high and low quality that may be put on the market. We uncover two effects that may lead the firm to overinvest in quality compared to a market with full information: first, an adverse selection effect according to which a sufficiently large investment can avoid adverse selection and, second, an efficiency effect according to which a larger investment reduces the probability of socially inefficient, low quality products in the market.

Keywords: asymmetric information, product quality

JEL Classification: D82, D92, L15

Suggested Citation

Belleflamme, Paul and Peitz, Martin, Asymmetric Information and Overinvestment in Quality (April 2009). CESifo Working Paper Series No. 2619. Available at SSRN: https://ssrn.com/abstract=1392141

Paul Belleflamme (Contact Author)

CORE and Louvain School of Management, UCL (Université Catholique de Louvain) ( email )

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CESifo (Center for Economic Studies and Ifo Institute)

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Martin Peitz

University of Mannheim - Department of Economics ( email )

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Germany
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HOME PAGE: http://peitz.vwl.uni-mannheim.de/

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