Reputation and uncertainty Toward an explanation of quality problems in competitive LDC markets

Abstract

This paper attempts to explain the puzzle of low and variable product qualities in seemingly competitive LDC markets. It shows that the cost of overcoming quality moral hazard through seller reputation rises with the rate of interest, the rate of seller turnover, the amplitude of idiosyncratic cost fluctuations, and the relative scarcity of exogenous entry costs. Since markets with a multiplicity of small producers are more likely to have these characteristics, they are more susceptible to suffering from quality problems. The model developed here in particular highlights the role of cost variations in impeding the function of reputation in markets with moral hazard and adverse selection. The derived conditions for the persistence of quality problems contribute to the explanation of quality differences between similar markets in developed and less developed countries.