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Endogenous Market Thickness, Prices and Honesty: Quality Demand Traps

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  • Siddhartha Bandyopadhyay

Abstract

We study the interaction between product quality, prices and demand in a dynamic model of asymmetric information. Sellers choose between producing high quality goods which gives low profits today but increases probability of future survival in the market and low quality ones which gives higher returns today but lowers future survival. However, demand depends on expected quality. Multiple steady states (high demand high quality, low demand low quality) exist if the present discounted value of lifetime profits from selling high quality goods exceeds a certain cutoff. We also characterise the equilibrium price which depends on the distribution of buyer valuations.

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File URL: ftp://ftp.bham.ac.uk/pub/RePEc/pdf/qtrapjan04.pdf
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Bibliographic Info

Paper provided by Department of Economics, University of Birmingham in its series Discussion Papers with number 05-02.

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Length: 31 pages
Date of creation: Jan 2005
Date of revision:
Handle: RePEc:bir:birmec:05-02

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Postal: Edgbaston, Birmingham, B15 2TT
Web page: http://www.economics.bham.ac.uk
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Keywords: market thickness; endogenous quality; multiple equilibria; price mechanism;

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  1. Kevin M. Murphy & Andrei Shleifer & Robert W. Vishny, 1988. "Industrialization and the Big Push," NBER Working Papers 2708, National Bureau of Economic Research, Inc.
  2. McLaren, J., 1996. "'Globalization' and Vertical Structure," Discussion Papers 1996_21, Columbia University, Department of Economics.
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  4. Igal Hendel & Alessandro Lizzeri, 1997. "Adverse Selection in Durable Goods Markets," NBER Working Papers 6194, National Bureau of Economic Research, Inc.
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  8. Adsera, Alicia & Ray, Debraj, 1998. " History and Coordination Failure," Journal of Economic Growth, Springer, vol. 3(3), pages 267-76, September.
  9. Shapiro, Carl, 1983. "Premiums for High Quality Products as Returns to Reputations," The Quarterly Journal of Economics, MIT Press, vol. 98(4), pages 659-79, November.
  10. Hopenhayn, Hugo A, 1992. "Entry, Exit, and Firm Dynamics in Long Run Equilibrium," Econometrica, Econometric Society, vol. 60(5), pages 1127-50, September.
  11. Akerlof, George A, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, MIT Press, vol. 84(3), pages 488-500, August.
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