Can High Prices Ensure Product Quality When Buyers Do Not Know the Sellers' Cost?
Indiana University, BEPP Working Paper No. 99.007
25 Pages Posted: 29 Sep 1999
Date Written: July 27, 2000
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.
JEL Classification: C72, L15
Suggested Citation: Suggested Citation