Asymmetric Information and Overinvestment in Quality
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 socially inefficient, low quality products in the market.
|Date of creation:||2009|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: +49 (89) 9224-0
Fax: +49 (89) 985369
Web page: http://www.cesifo.de
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Bagnoli, M. & Bergstrom, T., 1989.
"Log-Concave Probability And Its Applications,"
89-23, Michigan - Center for Research on Economic & Social Theory.
- Nelson, Philip, 1974. "Advertising as Information," Journal of Political Economy, University of Chicago Press, vol. 82(4), pages 729-54, July/Aug..
- Luis Cabral, 2000.
"Stretching Firm and Brand Reputation,"
00-07, New York University, Leonard N. Stern School of Business, Department of Economics.
- Cabral, L.M.B., 2000. "Stretching Firm and Brand Reputation," New York University, Leonard N. Stern School Finance Department Working Paper Seires 00-07, New York University, Leonard N. Stern School of Business-.
- Spence, A Michael, 1973. "Job Market Signaling," The Quarterly Journal of Economics, MIT Press, vol. 87(3), pages 355-74, August.
- de Meza, David & Webb, David C, 1987. "Too Much Investment: A Problem of Asymmetric Information," The Quarterly Journal of Economics, MIT Press, vol. 102(2), pages 281-92, May.
- Meurer, Michael & Stahl, Dale II, 1994. "Informative advertising and product match," International Journal of Industrial Organization, Elsevier, vol. 12(1), pages 1-19, March.
- Leland, Hayne E, 1979. "Quacks, Lemons, and Licensing: A Theory of Minimum Quality Standards," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1328-46, December.
- Andrew F. Daughety & Jennifer F. Reinganum, 2007.
"Communicating Quality: A Unified Model of Disclosure and Signaling,"
Vanderbilt University Department of Economics Working Papers
0703, Vanderbilt University Department of Economics.
- Andrew F. Daughety & Jennifer F. Reinganum, 2008. "Communicating quality: a unified model of disclosure and signalling," RAND Journal of Economics, RAND Corporation, vol. 39(4), pages 973-989.
- Daughety, Andrew & Reinganum, Jennifer, 1992.
"Product Safety: Liability, R & D and Signaling,"
94-17, University of Iowa, Department of Economics, revised 1994.
- Andrew Daughety & Jennifer Reinganum, .
"Secrecy and Safety,"
American Law & Economics Association Annual Meetings
1039, American Law & Economics Association.
- Andrew F. Daughety & Jennifer F. Reinganum, 2003. "Secrecy and Safety," Vanderbilt University Department of Economics Working Papers 0317, Vanderbilt University Department of Economics, revised Sep 2003.
- Jennifer F. Reinganum & Andrew F. Daughety, 2004. "Secrecy and Safety," Econometric Society 2004 North American Summer Meetings 53, Econometric Society.
- Jonathan Levin, 2001.
"Information and the Market for Lemons,"
01004, Stanford University, Department of Economics.
- Grossman, Sanford J, 1981. "The Informational Role of Warranties and Private Disclosure about Product Quality," Journal of Law and Economics, University of Chicago Press, vol. 24(3), pages 461-83, December.
- Paul R. Milgrom & John Roberts, 1984.
"Price and Advertising Signals of Product Quality,"
Cowles Foundation Discussion Papers
709, Cowles Foundation for Research in Economics, Yale University.
- Lensink, Robert & Sterken, Elmer, 2001.
"Asymmetric information, option to wait to invest and the optimal level of investment,"
Journal of Public Economics,
Elsevier, vol. 79(2), pages 365-374, February.
- Lensink, Robert & Sterken, Elmer, 1999. "Asymmetric information, option to wait to invest and the optimal level of investment," CCSO Working Papers 199917, University of Groningen, CCSO Centre for Economic Research.
- Gary Biglaiser, 1993. "Middlemen as Experts," RAND Journal of Economics, The RAND Corporation, vol. 24(2), pages 212-223, Summer.
- Anke S. Kessler, 1996.
"Revisiting the Lemons Market,"
Discussion Paper Serie A
517, University of Bonn, Germany.
- Steven Tadelis, 1999.
"What's in a Name? Reputation as a Tradeable Asset,"
American Economic Review,
American Economic Association, vol. 89(3), pages 548-563, June.
- Shiou Shieh, 1993. "Incentives for Cost-Reducing Investment in a Signalling Model of Product Quality," RAND Journal of Economics, The RAND Corporation, vol. 24(3), pages 466-477, Autumn.
- Klein, Benjamin & Leffler, Keith B, 1981. "The Role of Market Forces in Assuring Contractual Performance," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 615-41, August.
When requesting a correction, please mention this item's handle: RePEc:ces:ceswps:_2619. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Julio Saavedra)
If references are entirely missing, you can add them using this form.