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Ex ante Investment, Ex post Remedy, and Product Liability

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  • Chen, Yongmin
  • Hua, Xinyu

Abstract

Low-quality products may cause consumer harm. A firm can reduce the probability of low quality through ex ante investment before sales, and can take remedy actions such as product recalls if it learns after sales that product quality is low. An increase in the firm's product liability increases its incentive for ex post remedy; more ex post remedy, however, may reduce the firm's ex ante quality investment. On the other hand, higher product liability increases consumer demand for the product, resulting in high output and hence greater return to ex ante investment. The trade-off between these two effects, the "substitution effect" and the "output effect", can lead to an inverted U-shaped relationship between ex ante investment and product liability. We find that the firm always prefers full liability whereas consumers might be better off with less than full liability. Full product liability tends to be socially optimal when the potential consumer loss from low quality is sufficiently high; otherwise partial liability can be socially optimal.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 22031.

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Date of creation: 12 Apr 2010
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Handle: RePEc:pra:mprapa:22031

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Keywords: Ex ante Investment; Product Recall; Liability;

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  1. Eric T. Anderson & Karsten Hansen & Duncan Simester, 2009. "The Option Value of Returns: Theory and Empirical Evidence," Marketing Science, INFORMS, INFORMS, vol. 28(3), pages 405-423, 05-06.
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  7. Andrew F. Daughety & Jennifer F. Reinganum, 2003. "Markets, Torts and Social Inefficiency," Vanderbilt University Department of Economics Working Papers, Vanderbilt University Department of Economics 0308, Vanderbilt University Department of Economics.
  8. Hoffer, George E & Pruitt, Stephen W & Reilly, Robert J, 1988. "The Impact of Product Recalls on the Wealth of Sellers: A Reexamination," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(3), pages 663-70, June.
  9. Sridhar Moorthy & Kannan Srinivasan, 1995. "Signaling Quality with a Money-Back Guarantee: The Role of Transaction Costs," Marketing Science, INFORMS, INFORMS, vol. 14(4), pages 442-466.
  10. Steven Shavell, 1994. "Acquisition and Disclosure of Information Prior to Sale," RAND Journal of Economics, The RAND Corporation, The RAND Corporation, vol. 25(1), pages 20-36, Spring.
  11. Marino, Anthony M, 1997. "A Model of Product Recalls with Asymmetric Information," Journal of Regulatory Economics, Springer, Springer, vol. 12(3), pages 245-65, November.
  12. Gregg A. Jarrell & Sam Peltzman, 1984. "The Impact of Product Recalls on the Wealth of Sellers," University of Chicago - George G. Stigler Center for Study of Economy and State, Chicago - Center for Study of Economy and State 33, Chicago - Center for Study of Economy and State.
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