Endogenous Market Thickness, Prices and Honesty: Quality Demand Traps

Siddhartha Bandyopadhyay

Discussion Papers from Department of Economics, University of Birmingham

Abstract: We study the interaction between product quality, prices and demand in a dynamic model of asymmetric information. Sellers choose between producing high quality goods which gives low profits today but increases probability of future survival in the market and low quality ones which gives higher returns today but lowers future survival. However, demand depends on expected quality. Multiple steady states (high demand high quality, low demand low quality) exist if the present discounted value of lifetime profits from selling high quality goods exceeds a certain cutoff. We also characterise the equilibrium price which depends on the distribution of buyer valuations.

Keywords: market thickness; endogenous quality; multiple equilibria; price mechanism (search for similar items in EconPapers)
JEL-codes: L14 L15 O12 O17 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2005-01
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