Quality and Pricing Decisions in a Market with Consumer Information Sharing
Jiang B, Yang B (2017) "Quality and Pricing Decisions in a Market with Consumer Information Sharing," Management Science, Forthcoming
50 Pages Posted: 18 Oct 2015 Last revised: 14 Mar 2018
Date Written: August 20, 2017
We provide a dynamic, game-theoretic model to examine a firm’s quality and pricing decisions for a new experience good. Early consumers do not observe product quality prior to purchase but can learn it after purchase and share that product-quality information with later consumers, for example, through online reviews. Both the firm’s quality decision and its cost efficiency are the firm’s private information and not directly observed by the consumer. The early consumers can make a rational inference from the firm’s price about its cost and quality taking into account the firm’s profit incentive from the later informed consumers. We find that in equilibrium a more cost-efficient firm chooses higher quality than does an inefficient firm. One might intuit that a firm will offer higher quality if its high efficiency is known to consumers than if its efficiency is not known, because it will no longer need to convince consumers that it is not the inefficient firm. Our analysis shows that, surprisingly, the opposite may be true — when a firm’s high efficiency is publicly known, the firm may reduce its product quality rather than increase it. Furthermore, consumers’ knowledge about the firm’s cost efficiency can reduce the consumer surplus. We also show that an improvement in the average cost efficiency in the market can lower the consumer surplus.
Keywords: Asymmetric information, signaling, moral hazard, social learning, experience goods, quality, pricing
JEL Classification: D42, D82, L15
Suggested Citation: Suggested Citation