The Impacts of Labeling on Trade in Goods That may be Vertically Differentiated According to Quality
Following Nelson (1970) and Darby and Karni (1973), analysis of asymmetric information and product quality has focused on the distinction between search, experience, and credence goods. In the case of search goods, information to aid consumers in their purchasing decisions is often plentiful; thus, market failure is not a significant problem, and government regulatory activity is relatively minor (Caswell and Mojduszka 1996). Most analysis has focused on experience goods (Stiglitz 1989), with significant contributions being made by Klein and Leffler (1981), Shapiro (1983), Allen (1984), and Riordan (1986). Results in this literature rely on quality being signaled to consumers via reputation effects. For example, Klein and Leffler show that if firms incur sunk costs by investing in firm-specific assets that are observable by consumers, high-quality goods will be supplied in equilibrium.
KeywordsProfit Function Consumer Welfare Credence Good Vertical Differentiation Covered Market
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