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Vertical Product Differentiation When Quality is Unobservable to Buyers

Author

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  • Gerhard Orosel
  • Klaus G. Zauner

Abstract

We analyze vertical product differentiation in a model where a good’s quality is unobservable to buyers before purchase, a continuum of quality levels is technologically feasible, and minimum quality is supplied under competitive conditions. After purchase the true quality of the good is revealed with positive probability. To provide firms with incentives to actually deliver promised quality, prices must exceed marginal cost. We derive sufficient conditions for these incentive constraints to determine equilibrium prices, and show that under certain conditions only one or both of the extreme levels of quality, minimum and maximum quality, are available in the market.

Suggested Citation

  • Gerhard Orosel & Klaus G. Zauner, 2004. "Vertical Product Differentiation When Quality is Unobservable to Buyers," CESifo Working Paper Series 1271, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_1271
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    File URL: https://www.cesifo-group.de/DocDL/cesifo1_wp1271.pdf
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    References listed on IDEAS

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    14. Carl Shapiro, 1983. "Premiums for High Quality Products as Returns to Reputations," The Quarterly Journal of Economics, Oxford University Press, vol. 98(4), pages 659-679.
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    Cited by:

    1. Franco Mariuzzo & Patrick Paul Walsh & Ciara Whelan, 2004. "EU Merger Control in Differentiated Product Industries," CESifo Working Paper Series 1312, CESifo Group Munich.

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    Keywords

    experience goods; product differentiation; product quality; asymmetric information;

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