Topic 3 - Quality - Fall 2011 Topic 3 Market power and...

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Fall 2011 Topic 3: Market power and product quality Outline Quality provision for search goods Adverse selection Reading ch. 6 (pp. 183-96) Lectures : 6 EC620 Topic 3: Product quality 1 of 8
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Fall 2011 Quality provision for search goods If a good’s quality can be verified… …prior to purchase then it is a search good …after purchase then it is an experience good . Monopoly choice of q & s for a search good is… The efficient choice of q & s for a search good EC620 Topic 3: Product quality 2 of 8
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Fall 2011 Quality example ( P = s – 0.25 q , C = cq + (½) s 2 ) Monopoly choice of q and s Profits are π = ( s – 0.25 q – c ) q – (½) s 2 Differentiate with respect to q and s to get (1) π /∂ q = s – 0.5 q c = 0 (2) π /∂ s = q s = 0 Sub. (2) into (1) to get q = s = 2 c Welfare maximizing choice of q and s Welfare function is given by = Differentiate with respect to q and s to get (3) W /∂ q = s - 0.25 q c = 0 (4) W /∂ s = q - s = 0 Sub. (3) into (4) to get s = q = (4/3) c EC620 Topic 3: Product quality 3 of 8
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Fall 2011 Adverse selection and experience goods
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