Microeconomics and Prospect Theory: Effects of Risk Behavior onto Quality of Products Traded

7 Pages Posted: 25 May 2015 Last revised: 23 Nov 2015

Date Written: May 20, 2015

Abstract

Nobody would question the trade-off between product quality and price. However, negotiations between buyers and sellers tend to circle primarily around pricing, because it is a simple quantitative figure compared to product quality, which is much harder to comprehend. Every seller of good quality products does fear the race to the bottom, when uninformed buyers ask for discounts. To alleviate this situation, findings from behavioral economics, applied to basic market mechanisms, show a bias towards trade with higher quality products. The trade of money for goods is transferred into a choice for gain or for loss in ways considered a novel concept. Risk aversion and risk seeking of buyers can counterbalance market downturns, constituting a barrier against crooked sellers taking over the marketplace with low quality products. A basic model demonstrates that information symmetry is not necessarily a prerequisite to maintain a healthy market.

Keywords: product quality, lemon markets, prospect theory, decision under risk, information asymmetry

JEL Classification: A12, B23, D81

Suggested Citation

Stömmer, Ralph, Microeconomics and Prospect Theory: Effects of Risk Behavior onto Quality of Products Traded (May 20, 2015). Available at SSRN: https://ssrn.com/abstract=2609931 or http://dx.doi.org/10.2139/ssrn.2609931

Ralph Stömmer (Contact Author)

Private researcher ( email )

Karl-Birzer-Str. 20
Ottobrunn, 85521
Germany

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