Credence Goods, Misleading Labels, and Quality Differentiation

Soham Baksi (), Pinaki Bose () and Di Xiang ()
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Pinaki Bose: University of Manitoba
Di Xiang: Southwestern University of Finance and Economics

Environmental & Resource Economics, 2017, vol. 68, issue 2, No 7, 377-396

Abstract: Abstract 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.

Keywords: Credence goods; Misinformation; Vertical product differentiation (search for similar items in EconPapers)
JEL-codes: L15 M37 Q56 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (9)

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DOI: 10.1007/s10640-016-0024-4

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