Simple Reputation Systems

Abstract

This paper develops a model of simple 'reputation systems' that monitor and publish information about the behavior of sellers in a market with search frictions and asymmetric information. The reputations created by these systems influence the equilibrium search patterns of buyers and thus provide for market-based 'punishment' of bad behavior. Our model allows us to determine the effects of the introduction of a reputation system on the behavior and welfare of buyers and sellers in such a market. We show that a simple reputation system that rewards honesty can enhance welfare by allowing good sellers to truthfully signal their type. However, we also show that in some cases the same reputation system is prone to strategic manipulation by sellers who always have low quality products. In this case, we show that an alternative simple reputation system that screens for type can be superior