Product Quality, Reputation, and Market Structure

James D. Dana, Kellogg School of Management, Northwestern University
Yuk-Fai Fong, Northwestern University

Abstract

Firms in an oligopoly market can more easily maintain a reputation for a high quality experience good than a monopolist or firms in a competitive market. Intuitively, selling an experience good of unknown quality is like selling a primary good of known quality and a secondary upgrade of unknown quality. When a monopolist or a competitive firm deviates in the price or quality of its upgrade, they can anticipate that consumers will no longer buy the upgrade, but the profit they earn from their primary good is unchanged. On the other hand, when an oligopoly firm deviates in the price or quality of its upgrade, the firm can anticipate not only that consumers will no longer buy its upgrade but also that the price it can charge for its primary good will fall. We also find that for a wide range of parameter values consumer surplus is higher in any low quality equilibrium than in any high quality equilibrium, even when it is socially efficient to produce high quality.