Quality and Reputation: Is Competition Beneficial to Consumers?

Abstract

In this paper we develop a model of product quality and firms' reputation. If quality is not verifiable and there is repeated interaction between firms and consumers, we show that reputation emerges as a means of disciplining the former to deliver high quality. In order to that, we also prove that competitive firms can extract some rent in producing high quality, thus providing a solution to Stiglitz (1989) puzzle, alternative and complementary to Hörner's (2002) one. Positive profit are generated in equilibria characterized by the emergence of a social norm which prescribes a minimum quality level. Moreover, we demonstrate that more concentrated industry structures deliver better quality and higher social and consumer welfare. This finding should induce cautiousness in enhancing competition when product quality is at stake. We derive our results in the specific context of after-sales service quality provided by insurance companies. Yet, we argue that our analysis is of general applicability.quality, reputation, Bertrand competition, insurance contracts.