Consumer Reviews and Dynamic Price Signaling

Abstract

Consumer reviews do not reflect absolute product quality but rather quality relative to the price. We analyze a reputation model with a privately informed monopolist repeatedly selling its product to uninformed but rational consumers, who learn about product quality through past reviews and the current price. We show that in a fully dynamic model where price signaling is permitted, high and low-quality firms pool when product rating is high and separate when product rating is low. In the separating equilibrium, the high-quality firm discounts its good heavily, whereas the low-quality firm sells its good at face value. The amount of price discounting depends on the review process. Overall, our findings have the surprising implication that consumers benefit from extreme reviews and rating manipulation, at the expense of low-quality firms.

Keywords: Consumer Reviews, Reputation, Dynamic Pricing, Price Signaling

JEL Classification: D83, D21