Market Institutions and Quality Enforcement

Rudolf Kerschbamer, Muriel Niederle and Josef Perktold
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Josef Perktold: University of Chicago

No 1482, Econometric Society World Congress 2000 Contributed Papers from Econometric Society

Abstract: A competitive market for an experience good is considered where high quality is enforced by repeated game trigger strategies. The goods are demanded by long run (LR) and short run (SR) customers, the former buying repeatedly, the latter only once. SR buyers can free ride on quality enforcement by LR buyers but, by doing so, they may prevent LR buyers from punishing firms for producing low quality. We characterize equilibria in different market institutions and show that non-exclusivity has a negative impact on quality enforcement when the market institution provides some public information. In decentralized markets with only match specific information, some firms sell high quality to LR, others low quality to SR buyers. By contrast, in auction markets where past trading prices and quantities are publicly observed, SR buyers can buy from firms with high price histories. When a firm starts to produce low quality, its LR customers migrate to other firms but the punishment probability is lowerd by sales to SR buyers. A partial market breakdown results. The outcome can be improved by coordination among LR buyers, which allows a better use of information. Auction markets with a larger information flow, produce high punishment probabilities even without coordination. Better outcomes can be obtained if firms are allowed to price discriminate between LR and SR buyers. Without discrimination or exclusivity, information spillovers from LR to SR can reduce welfare. Depending on the market institution, more public information can improve the outcome but can also make it worse.

Date: 2000-08-01
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