Product Testing in Markets for Experience Goods

In markets for experience goods where sellers cannot build reputations, buyers may refrain from purchasing, leading to low efficiency. A product testing institution can mitigate this problem by offering buyers a noisy but informative signal about product quality for a fee before they decide whether to buy. Theory predicts that such testing improves efficiency only when the signal is inexpensive; if the cost is high, it should have no effect. Our experimental results confirm that low-cost signals increase efficiency, although the gains are smaller than expected. Surprisingly, high-cost signals also improve efficiency compared to a control treatment without signals. These findings suggest that institutions predicted to be ineffective by standard theory may nevertheless perform better in practice.