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Reviews, Prices and Endogenous Information Transmission

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  • Nicollier, Luciana A

    (Department of Economics, University of Warwick)

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    Abstract

    Empirical evidence suggests that online reviews are an important source of consumers information and a relevant determinant of the rms revenues. Little is known, however, about how prices and reviews a ect each other. This paper proposes a dynamic game to investigate this relationship. A long-lived monopoly faces a sequence of short-lived consumers whose only information about the value of an experience good is the one contained in the reviews completed by previous buyers. Neither the monopoly nor the consumers have private information about the value of the good. After buying the good, the consumers observe a quality realisation that is correlated with the actual value of the good and decide whether to complete reviews. The consumers complete reviews according to a social rule that maximises the present value of current and future consumers utility. It is shown that a necessary condition for the existence of reviews is that the firm cannot fully appropriate the surplus generated by this increased information. Furthermore, the reviews induce a mean preserving spread on the posterior beliefs about the value of the good which, combined with the convexity with respect to the prior of the indirect utility and profit functions, implies that reviews are valuable for both the consumers and the firm. Hence, both parties are willing to face some cost in order to increase the information available in the market. The main result of the paper is that, from the firm's perspective, this cost takes the form of a discount in the price o ered to current consumers. JEL classification: Customer Reviews ; Monopoly ; Information Transmission JEL codes: L12 ; L15; D42

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    Bibliographic Info

    Paper provided by University of Warwick, Department of Economics in its series The Warwick Economics Research Paper Series (TWERPS) with number 1029.

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    Date of creation: 2013
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    Handle: RePEc:wrk:warwec:1029

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    1. Paul R. Milgrom, 1981. "Good News and Bad News: Representation Theorems and Applications," Bell Journal of Economics, The RAND Corporation, vol. 12(2), pages 380-391, Autumn.
    2. Paul Resnick & Richard Zeckhauser & John Swanson & Kate Lockwood, 2006. "The value of reputation on eBay: A controlled experiment," Experimental Economics, Springer, vol. 9(2), pages 79-101, June.
    3. Bose, Subir & Orosel, Gerhard O & Ottaviani, Marco & Vesterlund, Lise, 2005. "Dynamic Monopoly Pricing and Herding," CEPR Discussion Papers 5003, C.E.P.R. Discussion Papers.
    4. Michael Luca, 2011. "Reviews, Reputation, and Revenue: The Case of Yelp.com," Harvard Business School Working Papers 12-016, Harvard Business School.
    5. Michael Waterson & Chris Doyle, 2012. "Your Call: eBay and Demand for the iPhone 4☆," International Journal of the Economics of Business, Taylor & Francis Journals, vol. 19(1), pages 141-152, February.
    6. Timothy Feddersen & Alvaro Sandroni, 2006. "A Theory of Participation in Elections," American Economic Review, American Economic Association, vol. 96(4), pages 1271-1282, September.
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