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Quality-Ensuring Profits

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  • Eric Rasmusen

    (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)

Abstract

In the reputation model of Klein and Leffler (1981) firms refrain from cutting quality or price because if they did they would forfeit future profits. Something similar can happen even in a static setting. First, if there exist some discerning consumers who can observe quality, firms wish to retain their purchases. Second, if all consumers can sometimes but not always spot flaws, firms do not want to lose the business of those who would spot them on a given visit. Third, if the law provides a penalty for fraud, but not one so high as to to make fraud unprofitable, firms may prefer selling high quality at high prices to low quality at high prices plus some chance of punishment.

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File URL: http://www.bus.indiana.edu/riharbau/RePEc/iuk/wpaper/bepp2008-10-rasmusen.pdf
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Bibliographic Info

Paper provided by Indiana University, Kelley School of Business, Department of Business Economics and Public Policy in its series Working Papers with number 2008-10.

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Date of creation: Mar 2008
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Handle: RePEc:iuk:wpaper:2008-10

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Related research

Keywords: reputation; product quality; moral hazard; quality-guaranteeing price;

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References

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  1. Joseph Farrell, 1985. "Moral Hazard as an Entry Barrier," Working papers 387, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Cooper, Russell & Ross, Thomas W, 1984. "Prices, Product Qualities and Asymmetric Information: The Competitive Case," Review of Economic Studies, Wiley Blackwell, vol. 51(2), pages 197-207, April.
  3. Kihlstrom, Richard E & Riordan, Michael H, 1984. "Advertising as a Signal," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 427-50, June.
  4. Klein, Benjamin & Leffler, Keith B, 1981. "The Role of Market Forces in Assuring Contractual Performance," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 615-41, August.
  5. Paul R. Milgrom & John Roberts, 1984. "Price and Advertising Signals of Product Quality," Cowles Foundation Discussion Papers 709, Cowles Foundation for Research in Economics, Yale University.
  6. 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.
  7. Bagwell, Kyle & Riordan, Michael H, 1991. "High and Declining Prices Signal Product Quality," American Economic Review, American Economic Association, vol. 81(1), pages 224-39, March.
  8. Andrew F. Daughety & Jennifer F. Reinganum, 2008. "Imperfect competition and quality signalling," RAND Journal of Economics, RAND Corporation, vol. 39(1), pages 163-183.
  9. David Kreps & Paul Milgrom & John Roberts & Bob Wilson, 2010. "Rational Cooperation in the Finitely Repeated Prisoners' Dilemma," Levine's Working Paper Archive 239, David K. Levine.
  10. Diamond, Douglas W, 1989. "Reputation Acquisition in Debt Markets," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 828-62, August.
  11. Maksimovic, Vojislav & Titman, Sheridan, 1991. "Financial Policy and Reputation for Product Quality," Review of Financial Studies, Society for Financial Studies, vol. 4(1), pages 175-200.
  12. Stiglitz, Joseph E, 1987. "The Causes and Consequences of the Dependence of Quality on Price," Journal of Economic Literature, American Economic Association, vol. 25(1), pages 1-48, March.
  13. Chan, Yuk-Shee & Leland, Hayne, 1982. "Prices and Qualities in Markets with Costly Information," Review of Economic Studies, Wiley Blackwell, vol. 49(4), pages 499-516, October.
  14. William P. Rogerson, 1983. "Reputation and Product Quality," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 508-516, Autumn.
  15. Linnemer, Laurent, 2002. "Price and advertising as signals of quality when some consumers are informed," International Journal of Industrial Organization, Elsevier, vol. 20(7), pages 931-947, September.
  16. Mark N. Hertzendorf & Per Baltzer Overgaard, 2001. "Price Competition and Advertising Signals: Signaling by Competing Senders," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 10(4), pages 621-662, December.
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