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Reputation and competition in a hidden action model.

Alessandro Fedele1, Piero Tedeschi2

  • 1School of Economics and Management, Free University of Bozen/Bolzano, Bozen/Bolzano, Italy.

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|October 21, 2014
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Summary

This study introduces a new economic model where reputation and Bertrand competition drive high-quality goods. Despite competition, firms sustain high quality through a stationary symmetric equilibrium, challenging prior assumptions.

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Area of Science:

  • Economics
  • Market Behavior
  • Game Theory

Background:

  • Reputation and quality models are categorized into pure hidden action, pure hidden information, and mixed frameworks.
  • Early economic models suggested competition hinders reputation's ability to ensure high product quality.

Purpose of the Study:

  • To develop a pure hidden action model of reputation and Bertrand competition.
  • To investigate how reputation and competition interact in markets with free entry and repeated consumer-firm interactions.

Main Methods:

  • Developed a theoretical economic model based on pure hidden action.
  • Incorporated Bertrand competition with free entry and repeated interactions.
  • Analyzed how consumers infer quality from past information and current prices.

Main Results:

  • Demonstrated that high quality levels can be sustained even under competitive market conditions.
  • Showed that reputation mechanisms can effectively induce high-quality production.
  • Identified a stationary symmetric equilibrium as the outcome sustaining high quality.

Conclusions:

  • Contradicts earlier theories suggesting competition erodes reputation's role in quality assurance.
  • Provides a mechanism for sustaining high quality in markets with imperfect information and competition.
  • Highlights the importance of repeated interactions and information inference in market dynamics.