The Value of a Reputation System
AbstractThis paper explores the trade-off between the short-term benefits of false quality advertisements against the longer term costs of reputation damage. A directed search model is constructed in which submarkets are created by the advertisements and reputations of sellers. A reputation system links misleading advertisements in the present period to a lower reputation in the next period. We show that a reputation system always increases the prices of high quality products and directs search more accurately towards the sellers with such products. We also show that buyers are hurt by a reputation system if the market is thin -- has few sellers -- because the equilibrium increase in prices is greater than the equilibrium increase in the quality of trade. Finally, we show that a reputation system which screens for honesty increases social welfare by making sellers more truthful. However, we also show that a reputation for honesty is not always highly valued and that an alternative reputation system which screens for type can be more effective.
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Bibliographic InfoPaper provided by EconWPA in its series Industrial Organization with number 0301011.
Length: 31 pages
Date of creation: 23 Jan 2003
Date of revision:
Note: Type of Document - PDF; prepared on IBM PC - PC-TEX; to print on Any; pages: 31 ; figures: included
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reputation systems; directed search;
Find related papers by JEL classification:
- D44 - Microeconomics - - Market Structure and Pricing - - - Auctions
- D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
- M37 - Business Administration and Business Economics; Marketing; Accounting - - Marketing and Advertising - - - Advertising
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