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The Value of a Reputation System

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Author Info

  • John Kennes

    (The University of Auckland)

  • Aaron Schiff

    (The University of Auckland)

Abstract

This 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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File URL: http://128.118.178.162/eps/io/papers/0301/0301011.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Industrial Organization with number 0301011.

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Length: 31 pages
Date of creation: 23 Jan 2003
Date of revision:
Handle: RePEc:wpa:wuwpio:0301011

Note: Type of Document - PDF; prepared on IBM PC - PC-TEX; to print on Any; pages: 31 ; figures: included
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Web page: http://128.118.178.162

Related research

Keywords: reputation systems; directed search;

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References

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  1. John Kennes & Benoit Julien & Ian King, 2002. "The Mortensen Rule and Efficient Coordination Unemployment," Macroeconomics 0206001, EconWPA.
  2. Fudenberg, Drew & Kreps, David M, 1987. "Reputation in the Simultaneous Play of Multiple Opponents," Review of Economic Studies, Wiley Blackwell, vol. 54(4), pages 541-68, October.
  3. David Kreps & Robert Wilson, 1999. "Reputation and Imperfect Information," Levine's Working Paper Archive 238, David K. Levine.
  4. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
  5. McAfee, R Preston & McMillan, John, 1987. "Auctions and Bidding," Journal of Economic Literature, American Economic Association, vol. 25(2), pages 699-738, June.
  6. Kultti, Klaus, 1999. "Equivalence of Auctions and Posted Prices," Games and Economic Behavior, Elsevier, vol. 27(1), pages 106-113, April.
  7. Kenneth Burdett & Shouyong Shi & Randall Wright, 2001. "Pricing and Matching with Frictions," Journal of Political Economy, University of Chicago Press, vol. 109(5), pages 1060-1085, October.
  8. George J. Stigler, 1961. "The Economics of Information," Journal of Political Economy, University of Chicago Press, vol. 69, pages 213.
  9. Julien, B. & Kennes, J. & King, I., 1998. "Bidding for Labour," Working Papers dp98-03, CRABE, Department of Economics, Simon Fraser University.
  10. Moen, Espen R, 1997. "Competitive Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 385-411, April.
  11. Wolinsky, Asher, 1988. "Dynamic Markets with Competitive Bidding," Review of Economic Studies, Wiley Blackwell, vol. 55(1), pages 71-84, January.
  12. Ellison, Glenn, 1994. "Cooperation in the Prisoner's Dilemma with Anonymous Random Matching," Review of Economic Studies, Wiley Blackwell, vol. 61(3), pages 567-88, July.
  13. Diamond, Douglas W, 1989. "Reputation Acquisition in Debt Markets," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 828-62, August.
  14. Spence, A Michael, 1973. "Job Market Signaling," The Quarterly Journal of Economics, MIT Press, vol. 87(3), pages 355-74, August.
  15. 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.
  16. McAfee, R Preston, 1993. "Mechanism Design by Competing Sellers," Econometrica, Econometric Society, vol. 61(6), pages 1281-1312, November.
  17. John Kennes & Ian Paul King & Benoit Julien, 2002. "'Residual' Wage Disparity in Directed Search Equilibrium," Macroeconomics 0205003, EconWPA.
  18. Coles, Melvyn G. & Eeckhout, Jan, 2003. "Indeterminacy and directed search," Journal of Economic Theory, Elsevier, vol. 111(2), pages 265-276, August.
  19. Benoît Julien & John Kennes & Ian King, 2002. "Auctions Beat Posted Prices in a Small Market," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 158(4), pages 548-, December.
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Cited by:
  1. John Kennes, 2004. "Competitive Auctions: Theory and Application," Discussion Papers 04-16, University of Copenhagen. Department of Economics.

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