Reputation and Turnover
28 Pages Posted: 6 Aug 2004
Date Written: August 4, 2004
We consider a repeated duopoly game where each firm privately chooses its investment in quality, and realized quality is a noisy indicator of the firm's investment. We focus on dynamic reputation equilibria, whereby consumers "discipline" a firm by switching to its rival in the case that the realized quality of its product is too low. This type of equilibrium is characterized by consumers' tolerance level - the level of product quality below which consumers switch to the rival firm - and firms' investment in quality. Given consumers' tolerance level, we determine when a dynamic equilibrium that gives higher welfare than the static equilibrium exists. We also derive comparative statics properties, and characterize a set of investment levels and, hence, payoffs that our equilibria sustain.
Keywords: Reputation, consumer switching, moral hazard, repeated games
JEL Classification: C73, D82, L14, L15
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