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Moral Hazard as an Entry Barrier

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Author Info
Joseph Farrell

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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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Publisher 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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  1. Gene M. Grossman & Henrik Horn, 1989. "Infant-Industry Protection Reconsidered: The Case of Informational Barriers to Entry," NBER Working Papers 2159, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. J. Miguel Villas-Boas, 2000. "Competing with Experience Goods," Econometric Society World Congress 2000 Contributed Papers 0771, Econometric Society. [Downloadable!]
  3. Dirk Bergemann & Juuso Valimaki, 1999. "Entry and Innovation in Vertically Differentiated Markets," Cowles Foundation Discussion Papers 1226, Cowles Foundation, Yale University. [Downloadable!]
    Other versions:
  4. Gehrig, Thomas & Stenbacka, Rune, 2002. "Introductory Offers in a Model of Strategic Competition," CEPR Discussion Papers 3189, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  5. Kyle Bagwell, 1986. "Informational Product Differentiation as a Barrier to Entry," Discussion Papers 711, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
    Other versions:
  6. Goh, Ai Ting & Michalski, Tomasz, 2008. "Quality Assurance and the Home Market Effect," CEPR Discussion Papers 6880, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  7. Martin Peitz & Paolo G. Garella, 1999. "- Exclusive Dealing Clauses Facilitate Entry," Working Papers. Serie AD 1999-17, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie). [Downloadable!]
  8. 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, vol. 33(3), pages 347-383, September. [Downloadable!]
  9. Dirk Bergemann & Juuso Valimaki, 2004. "Monopoly Pricing of Experience Goods," Cowles Foundation Discussion Papers 1463R, Cowles Foundation, Yale University, revised May 2005. [Downloadable!]
  10. Yoonhee Tina Chang, 2004. "Relationship Banking in Bilateral Oligopoly and Asymmetric Information," Econometric Society 2004 Far Eastern Meetings 734, Econometric Society. [Downloadable!]
  11. M Suresh Babu, 2007. "Economic Reforms And Entry Barriers In Indian Manufacturing," Working Papers id:978, esocialsciences.com. [Downloadable!]
  12. Paolo Giorgio GARELLA & Martin PEITZ, 2006. "Alliances between competitors and consumer information," Departemental Working Papers 2006-41, Department of Economics University of Milan Italy. [Downloadable!]
    Other versions:
  13. Eric Rasmusen, 2008. "Quality-Ensuring Profits," Working Papers 2008-10, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy. [Downloadable!]
  14. Bijl, P.W.J. de, 1995. "Entry Deterrence and Signaling in Markets for Search Goods," Discussion Paper 16, Tilburg University, Center for Economic Research. [Downloadable!]
    Other versions:
  15. M. Suresh Babu, 2002. "Economic reforms and entry barriers in Indian manufacturing," Centre for Development Studies, Trivendrum Working Papers 331, Centre for Development Studies, Trivendrum, India. [Downloadable!]
  16. Kyle Bagwell & R. Staiger, 1987. "The Role of Export Subsidies When Product Quality is Unknown," Discussion Papers 758, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
    Other versions:
  17. Raff, Horst & von der Ruhr, Marc, 2001. "Foreign Direct Investment in Producer Services: Theory and Empirical Evidence," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
    Other versions:
  18. Martin Peitz, 2000. "Exclusionary Practices and Entry Under Asymmetric Information," Econometric Society World Congress 2000 Contributed Papers 1197, Econometric Society. [Downloadable!]
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