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Moral Hazard as an Entry Barrier

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  • Joseph Farrell

Abstract

In an experience-goods industry, an entrant who could make positive profits by providing a better deal to buyers than do incumbents may cheat buyers by providing goods of low quality to make even greater profits. If buyers foresee this possibility, they will be unwilling to buy from an entrant. As a result, moral hazard in a seller's choice of the quality of an experience good can lead to a barrier to entry. In particular, since hit-and-run entry is likely to lead to low-quality choice, the threat of such entry may not discipline the pricing of incumbents. We also show that the temptation to dishonest entry -- the moral hazard problem -- is stronger if buyers are already receiving some consumer surplus. As a result, there is a first-entrant advantage because the first entrant faces less temptation to provide inefficiently low quality than do subsequent entrants, and with rational buyers this works to his advantage. The scale of entry may affect quality incentives, and therefore introductory offers may assure buyers of an entrant's quality but this cannot happen under a suitable definition of "constant returns."

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Bibliographic Info

Article provided by The RAND Corporation in its journal RAND Journal of Economics.

Volume (Year): 17 (1986)
Issue (Month): 3 (Autumn)
Pages: 440-449

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Handle: RePEc:rje:randje:v:17:y:1986:i:autumn:p:440-449

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Cited by:
  1. de Bijl, Paul W. J., 1997. "Entry deterrence and signaling in markets for search goods," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 16(1), pages 1-19, November.
  2. Goh, Ai Ting & Michalski, Tomasz, 2008. "Quality Assurance and the Home Market Effect," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6880, C.E.P.R. Discussion Papers.
  3. Martin Peitz & Paolo G. Garella, 1999. "- Exclusive Dealing Clauses Facilitate Entry," Working Papers. Serie AD, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie) 1999-17, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
  4. Gene M. Grossman & Henrik Horn, 1987. "Infant-Industry Protection Reconsidered: The Case of Informational Barriers to Entry," NBER Working Papers 2159, National Bureau of Economic Research, Inc.
  5. Martin Peitz, 2000. "Exclusionary Practices and Entry Under Asymmetric Information," Econometric Society World Congress 2000 Contributed Papers, Econometric Society 1197, Econometric Society.
  6. Raff, Horst & Kim, Young-Han, 1999. "Optimal export policy in the presence of informational barriers to entry and imperfect competition," Journal of International Economics, Elsevier, Elsevier, vol. 49(1), pages 99-123, October.
  7. Egbert, Henrik & Greiff, Matthias & Xhangolli, Kreshnik, 2014. "PWYW Pricing ex post Consumption: A Sales Strategy for Experience Goods," MPRA Paper 53376, University Library of Munich, Germany.
  8. J. Miguel Villas-Boas, 2000. "Competing with Experience Goods," Econometric Society World Congress 2000 Contributed Papers, Econometric Society 0771, Econometric Society.
  9. Horst Raff & Marc von der Ruhr, 2001. "Foreign Direct Investment in Producer Services: Theory and Empirical Evidence," CESifo Working Paper Series, CESifo Group Munich 598, CESifo Group Munich.
  10. M Suresh Babu, 2007. "Economic Reforms And Entry Barriers In Indian Manufacturing," Working Papers id:978, eSocialSciences.
  11. Bagwell, Kyle, 1990. "Informational product differentiation as a barrier to entry," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 8(2), pages 207-223, June.
  12. Hintermann, Beat & Lange, Andreas, 2013. "Learning abatement costs: On the dynamics of the optimal regulation of experience goods," Journal of Environmental Economics and Management, Elsevier, vol. 66(3), pages 625-638.
  13. Tirole, Jean, 2002. "Rational irrationality: Some economics of self-management," European Economic Review, Elsevier, Elsevier, vol. 46(4-5), pages 633-655, May.
  14. Osiris Jorge Parcero & Emiliano Villanueva, 2011. "World Wine Exports: What Determined the Success of the ‘New World’ Wine Producers?," CRIEFF Discussion Papers, Centre for Research into Industry, Enterprise, Finance and the Firm 1103, Centre for Research into Industry, Enterprise, Finance and the Firm.
  15. Eric Rasmusen, 2008. "Quality-Ensuring Profits," Working Papers, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy 2008-10, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  16. Gehrig, Thomas & Stenbacka, Rune, 2002. "Introductory Offers in a Model of Strategic Competition," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3189, C.E.P.R. Discussion Papers.
  17. Beat Hintermann & Andreas Lange, 2012. "Learning Abatement Costs: On the Dynamics of Optimal Regulation of Experience Goods," CESifo Working Paper Series, CESifo Group Munich 4058, CESifo Group Munich.
  18. Nizovtsev, Dmitri & Novshek, William, 2004. "Money-back guarantees and market experimentation," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 22(7), pages 983-996, September.
  19. Sergi Jiménez-Martín & Antonio Ladrón de Guevara-Martínez, 2009. "A state-dependent model of hybrid behavior with rational consumers in the attribute space," Investigaciones Economicas, Fundación SEPI, Fundación SEPI, vol. 33(3), pages 347-383, September.

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