Informational Cascades in Informal Markets

Abstract

Many agents and a lack of enforceable contracts have been provided as explanations for the predominance of low quality experience goods in informal markets. We propose that imperfectly informed consumers may rationally use observations of other consumers' purchases as additional information of product quality. We analyze how such behavior affects the price choices of sellers who are not constrained by other types of reputation mechanisms. In a game theoretic model, we derive the conditions for equilibria in which low quality drives out high quality, or low and high quality are sold at the same price to consumers with homogeneous tastes. (LIO, C70)