Quality-Ensuring Profits

Eric Rasmusen ()

No 2008-10, Working Papers from Indiana University, Kelley School of Business, Department of Business Economics and Public Policy

Abstract: In the reputation model of Klein and Leffler (1981) firms refrain from cutting quality or price because if they did they would forfeit future profits. Something similar can happen even in a static setting. First, if there exist some discerning consumers who can observe quality, firms wish to retain their purchases. Second, if all consumers can sometimes but not always spot flaws, firms do not want to lose the business of those who would spot them on a given visit. Third, if the law provides a penalty for fraud, but not one so high as to to make fraud unprofitable, firms may prefer selling high quality at high prices to low quality at high prices plus some chance of punishment.

Keywords: reputation; product quality; moral hazard; quality-guaranteeing price (search for similar items in EconPapers)
Date: 2008-03
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