ECONOMICS 3200M Lecture 17 March 20, 2006

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ECONOMICS 3200MLecture 17March 20, 2006
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Information

• Classification of products according to ex
  ante/ex post information of consumers re. quality
• Search products quality know ex ante
• Experience products quality unknown ex ante (at
  least prior to 1st time consumption/use), but
  known ex post after purchase and use
• Credence products quality unknown ex ante and
  unknown ex post even after purchase and use
  services
• Importance of reputation

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Information

• Experience products no warranties
• One-time purchase e.g.., restaurants in foreign
  cities
• Assume two possible qualities SL, SH with
  corresponding unit costs CL lt CH and consumers
  willingness to pay PL lt PH
• Assume PH CH gt PL - CL
• Consumers imperfectly informed (non-rational
  expectations), buy one unit ( no repeat
  purchases)
• Assume U(SH, PH) gt U(SL, PL)
• Incentive for producers to claim high quality
  product even though low quality PH CL gt PH
  CH
• Lemons model

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Information

• Experience products no warranties
• Repeat purchase some informed customers, e.g..,
  restaurants in foreign cities again
• Assume some consumers informed of quality because
  of past purchases
• ? informed
• If producers quality is SH ?H PH CH per
  unit and all consumers buy
• If producers quality is SL ?L (1- ? )(PH
  CL ) per unit and only uninformed consumers buy
• Monopolist supplies SH if ?H gt ?L
• ? PH gt CH (1- ?) CL
• Sufficiently high price for high quality product,
  large proportion of informed consumers, small
  unit cost differential

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Information

• Experience products reputation, brand names
• Repeat purchase repeated games
• Two-period game
• Price in pd. 1 is P1 PH gt P1 gt PL (a priori
  probability that quality is SH is X)
• If monopolist produces SH ?H (P1 CH) ?(PH
  CH)
• If monopolist produces SL ?L (P1 CL) ?(PL
  CL)
• Assume PL CL 0
• ?H - ?L ?(PH CH) (CH - CL)
• Future return from goodwill less cost
  disadvantage
• Two-period game fixed end-point, Prisoners
  dilemma no incentive to build goodwill (brand
  name)
• Warranty

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Information

• Repeat purchase repeated games
• In multi-period game with uncertain end-point or
  infinite number of periods, incentive to build up
  goodwill and greater return on goodwill
• Low introductory offer in period 1 to attract
  customers to high quality product
• Reputation
• Alternatively, firm invests in advertising in
  period 1 commitment to demonstrate credibility
• Only high quality supplier can invest in
  advertising and earn return on investment
• Leverage brand name into other products/geographic
  markets
• Overcomes entry barriers
• Examples Armani into perfumes, glasses Marriott
  into different categories of hotels Sony into
  different consumer electronic products Donald
  Trump into different city real estate markets

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Information

• Labour markets
• Information re. safety, promotion (future
  earnings) opportunities, employment stability
• Reputation of employers
• Role of regulation experience and credence
  products
• Certification to practice a profession
• Standards environment, product quality, safety,
  workplace
• Liability laws, other laws securities,
  environment, tort, banking, transportation safety
• Outsourcing
• Transactions costs
• Information re.quality, reliability ISO
  certification
• Reputation of outsourcer e.g. Celestica

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Information

• Government regulation
• Consumers uninformed re.monitoring,enforcement,
  scope of regulations/laws
• Moral hazard potential consumers overestimate
  scope of regulations/laws
• Safety
• Deposit insurance
• Bankruptcy of companies engaged in travel
  industry e.g. Jetsgo
• Workplace safety

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Advertising

• Informational vs.persuasive
• Price, product characteristics, availability
  (distribution channels)
• Search,experience, credence
• Mutual fund companies advertising performance of
  their funds, types of funds during RRSP season
• Advertising prices ? lower average prices for
  consumers
• For most professional services, advertising
  prices usually not permitted by regulatory bodies
  required to ensure ethical behavior
• Image, quality
• Search, experience, credence

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Advertising

• Sales/marketing
• Segmentation of customers
• Individuals income, ethnicity, age, education,
  etc., strategies of rivals
• Firms size, location, alternative sources of
  supply, strategies of rivals
• Advertising strategies and budgets different
  media
• Trade shows
• Internal sales force vs. independent sales agents
  exclusive arrangements
• Technical skills pharmaceutical companies
  (basis for competitive advantage), aircraft
  manufacturers
• Internet sites
• Distribution channels commission overrides,
  promotional budgets

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Advertising

• Profit maximization and advertising
• P P(Q, A) ? inverse demand function with demand
  depending upon quantum of advertising
  expenditures
• Past advertising expenditures investment
  capital stock
• Possibility of depreciation of stock of
  advertising rate of depreciation may vary with
  media
• Profit function P(Q, A)Q C(Q) A
• Profit maximization conditions
• MRMC
• Q?P/ ?Q P ?C/ ?Q
• Q ?P/ ?A 1 ? A/PQ ?A/?
• However, different media for reaching consumers
  relative importance of informational vs.
  persuasive advertising
• Prisoners dilemma