Credence Goods, Misleading Labels, and Quality Differentiation
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Due to differences in information disclosure mechanisms, consumer misinformation about the quality of many credence goods is more endemic at intermediate levels of the quality spectrum rather than at the extremes. Using an oligopoly model of vertical product differentiation, we examine how consumers’ overestimation of the quality of intermediate-quality products affects firms’ incentives to improve product quality. The firms non-cooperatively choose the quality of their product before choosing its price or quantity. Irrespective of the nature of second stage competition, Bertrand or Cournot, we find that quality overestimation by consumers increases profit of the intermediate-quality firm, and motivates it to raise its product’s quality. In response, the high-quality firm improves its product quality even further but ends up with lower profit. Overall, average quality of the vertically differentiated product improves, which raises consumer surplus. Social welfare increases when the firms compete in prices but falls when they compete in quantities.
KeywordsCredence goods Misinformation Vertical product differentiation
JEL ClassificationQ56 L15 M37
We thank Arnab Basu, Amrita Ray Chaudhuri, Ngo Van Long, anonymous referees and a co-editor of this journal for useful comments and suggestions. Financial support for this research from Social Sciences and Humanities Research Council of Canada and the University of Winnipeg’s Board of Regents is gratefully acknowledged. The usual disclaimer applies.
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