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Asymmetric information and overinvestment in quality

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  • Belleflamme, Paul
  • Peitz, Martin

Abstract

In a standard adverse selection world, asymmetric information about product quality leads to quality deterioration in the market. Suppose that a higher investment level makes the realization of high quality more likely. Then, if consumers observe the investment (but not the realization of product quality) before purchase, they can infer the probability distribution of high and low quality that may be put on the market. We uncover two effects that may lead the firm to overinvest in quality compared to a market with full information: first, an adverse selection effect according to which a sufficiently large investment can avoid adverse selection and, second, an efficiency effect according to which a larger investment reduces the probability of having in the market low quality products that are not socially valuable.

Suggested Citation

  • Belleflamme, Paul & Peitz, Martin, 2014. "Asymmetric information and overinvestment in quality," European Economic Review, Elsevier, vol. 66(C), pages 127-143.
  • Handle: RePEc:eee:eecrev:v:66:y:2014:i:c:p:127-143
    DOI: 10.1016/j.euroecorev.2013.12.005
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    References listed on IDEAS

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    Cited by:

    1. Anthony Creane & Thomas D. Jeitschko, 2016. "Endogenous Entry in Markets with Unobserved Quality," Journal of Industrial Economics, Wiley Blackwell, vol. 64(3), pages 494-519, September.
    2. Belleflamme,Paul & Peitz,Martin, 2015. "Industrial Organization," Cambridge Books, Cambridge University Press, number 9781107687899, May.
    3. repec:eee:ejores:v:263:y:2017:i:3:p:1109-1122 is not listed on IDEAS

    More about this item

    Keywords

    Asymmetric information; Product quality; Adverse selection;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

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