Product Quality, Reputation, and Market Structure

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. The impact on welfare is ambiguous. We show that an increase in the number of firms can increase the highest sustainable quality without lowering the highest sustainable prices, a welfare increase. However we also show that an increase in the number of firms can lower both the highest sustainable price and the highest sustainable quality, which has ambiguous consequences for welfare.