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Can High Prices Ensure Product Quality When Buyers do not Know the Sellers' Cost?

Author

Listed:
  • Eric Rasmusen

    (Indiana University, Kelley School of Business)

  • Timothy Perri

    (Appalachian State University)

Abstract

The Klein-Leffler (1981) model of product quality does not explain why high-quality firms would dissipate the rents they earn from quality- assuring price premia, and it relies on consumers knowing the cost functions of firms. In the present paper, consumers do not know any firm's cost of producing quality goods, so high-quality firms must engage in conspicuous spending to demonstrate they earn a profitable mark-up over cost. Complete rent dissipation occurs only when high and low cost firms have the same cost of producing low quality.

Suggested Citation

  • Eric Rasmusen & Timothy Perri, 1999. "Can High Prices Ensure Product Quality When Buyers do not Know the Sellers' Cost?," Industrial Organization 9907002, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpio:9907002
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    References listed on IDEAS

    as
    1. Breen, Denis A, 1977. "The Monopoly Value of Household-Goods Carrier Operating Certificates," Journal of Law and Economics, University of Chicago Press, vol. 20(1), pages 153-185, April.
    2. Klein, Benjamin & Leffler, Keith B, 1981. "The Role of Market Forces in Assuring Contractual Performance," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 615-641, August.
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    Cited by:

    1. Rasmusen, Eric, 2017. "A model of trust in quality and North–South trade," Research in Economics, Elsevier, vol. 71(1), pages 159-170.
    2. Klerman, Daniel & de Figueiredo, Miguel F.P., 2021. "Reputational economies of scale," International Review of Law and Economics, Elsevier, vol. 65(C).
    3. Eric Rasmusen, 2007. "A Reputation Model of Quality in North-South Trade," Working Papers 2007-06, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.

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    More about this item

    Keywords

    product quality; Klein-Leffler; reputation; efficiency wage; repeated games; rent dissipation;
    All these keywords.

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

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