Durability and market organization under uncertainty

Abstract

In the past two decades, there has been great controversy in theoretical discussions on the effect of market organization on the durability of durable goods. Modern view is one where both a monopolist and a competitive industry choose the same durability and thus durability is independent of market organization. This dissertation analyzes the effect of market organization on durability by relaxing the crucial assumption of perfect substitutability among durable goods with different durability. When durable goods have a stochastic nature in their durability, risk-averse consumers are not indifferent among durable goods with different mean durability since they are imperfect substitutes for each other with respect to the risk level. The consumers find the optimal mean durability which minimizes risk when they purchase durable goods. Firms have to choose the durability level of durable goods given the existence of consumers' demand for mean durability. This dissertation shows that Swan's independence result holds only when both consumers and firms are risk neutral. The level of durability chosen under this situation minimizes the cost of providing service flow. However, when consumers are risk averse and firms are risk neutral, Swan's independence result does not hold even under constant returns to scale. A monopolist makes goods more durable than does a competitive industry when consumers reveal a negative value on the marginal increase in mean durability. This result is strikingly different from the traditional view and from Swan's independence result. On the other hand, when consumers impose a positive value on the marginal increase in mean durability, a competitive industry will make goods more durable than would a monopolist. This result is consistent with the traditional view. In both cases a competitive industry chooses more wants-satisfying durability. These levels of durability are different from Swan's independence result. This adverse selection of durability can be thought of as a social cost of uncertainty and consumers' attitude toward it. The extension of the major results from this dissertation would be the effect of market organization on product quality. This dissertation suggests that a competitive industry, in general, will produce goods with higher quality than would a monopolist.