Market thickness, prices and honesty: A quality demand trap

We analyze how product quality, prices and demand interact in a dynamic model of asymmetric information. We show that in markets for experience goods, even in the absence of certification, trade may occur, arising from a relation between market thickness and the incentive of sellers to produce high quality. We characterize the equilibrium prices, which depend on the distribution of buyer valuations. Finally, we show that the relationship between market thickness and incentive to produce high quality goods exists up to a certain threshold level of demand.

► Product quality, prices and demand interaction in a dynamic model.
► Shows existence of multiple steady states.
► Equilibrium prices depend on the distribution of buyer valuations.