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Endogenous Market Thickness, Prices and Honesty: Quality Demand Traps

  • Siddhartha Bandyopadhyay

We study the interaction between product quality, prices and demand in a dynamic model of asymmetric information. Sellers choose between producing high quality goods which gives low profits today but increases probability of future survival in the market and low quality ones which gives higher returns today but lowers future survival. However, demand depends on expected quality. Multiple steady states (high demand high quality, low demand low quality) exist if the present discounted value of lifetime profits from selling high quality goods exceeds a certain cutoff. We also characterise the equilibrium price which depends on the distribution of buyer valuations.

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File URL: ftp://ftp.bham.ac.uk/pub/RePEc/pdf/qtrapjan04.pdf
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Paper provided by Department of Economics, University of Birmingham in its series Discussion Papers with number 05-02.

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Length: 31 pages
Date of creation: Jan 2005
Date of revision:
Handle: RePEc:bir:birmec:05-02
Contact details of provider: Postal: Edgbaston, Birmingham, B15 2TT
Web page: http://www.economics.bham.ac.uk

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  1. Murphy, Kevin M. & Shleifer, Andrei & Vishny, Robert W., 1989. "Industrialization and the Big Push," Scholarly Articles 3606235, Harvard University Department of Economics.
  2. Hopenhayn, Hugo A, 1992. "Entry, Exit, and Firm Dynamics in Long Run Equilibrium," Econometrica, Econometric Society, vol. 60(5), pages 1127-50, September.
  3. Grossman, Gene M & Horn, Henrik, 1988. "Infant-Industry Protection Reconsidered: The Case of Informational Barriers to Entry," The Quarterly Journal of Economics, MIT Press, vol. 103(4), pages 767-87, November.
  4. John McLaren, 2000. ""Globalization" and Vertical Structure," American Economic Review, American Economic Association, vol. 90(5), pages 1239-1254, December.
  5. Abhijit V. Banerjee & Andrew F. Newman, 1990. "Occupational Choice and the Process of Development," Discussion Papers 911, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  6. Adsera, Alicia & Ray, Debraj, 1998. " History and Coordination Failure," Journal of Economic Growth, Springer, vol. 3(3), pages 267-76, September.
  7. Basu, Kaushik, 1986. "One Kind of Power," Oxford Economic Papers, Oxford University Press, vol. 38(2), pages 259-82, July.
  8. Shapiro, Carl, 1983. "Premiums for High Quality Products as Returns to Reputations," The Quarterly Journal of Economics, MIT Press, vol. 98(4), pages 659-79, November.
  9. Igal Hendel & Alessandro Lizzeri, 1997. "Adverse Selection in Durable Goods Markets," NBER Working Papers 6194, National Bureau of Economic Research, Inc.
  10. Greif, Avner & Milgrom, Paul & Weingast, Barry R, 1994. "Coordination, Commitment, and Enforcement: The Case of the Merchant Guild," Journal of Political Economy, University of Chicago Press, vol. 102(4), pages 745-76, August.
  11. 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.
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