Market organization and product quality under asymmetric information : a comparison of monopoly and competitive market

Abstract

A comparison of product qualities across different market structures has been a major issue in the economic analysis of quality determination. The literature focused in particular on the difference in product quality between monopoly and competitive markets. Earlier studies showed that a monopoly firm produces a lower quality than a competitive firm. This result was accepted as a conventional wisdom until Swan's provocative result was published. Swan pointed out an error in earlier studies and proved that the level of quality is independent of the market structure, if the quality is known to buyers with certainty. Swan's result was so counter-intuitive that numerous studies attempted to find the root of his result by relaxing some of his assumptions, but without much success. Swan's result proved to be quite robust. This dissertation reexamines Swan's result under asymmetric information on quality, i.e., when some buyers cannot distinguish between high and low qualities. The Cooper and Ross competitive market model of quality determination under asymmetric information is modified and extended for the analysis. The equilibrium price, quantity and quality are compared between monopoly and competitive markets, in which two levels of quality are traded at a uniform price. This comparison leads to five major findings. First, the level of quality in a monopoly market is lower than that in a competitive market, contradicting Swan's result. Second, total quantity of a high quality good supplied by competitive firms is greater than that by a monopoly firm, while the quantity of low quality good supplied by competitive firms is smaller than that of a monopoly firm. Third, the monopoly price is higher than the competitive price. Fourth, the probability for an uninformed buyer to choose a high quality good in the monopoly market is higher than that in the competitive market. Finally, the utility of an informed buyer is lower in the monopoly market than in a competitive market, a result of a diseconomy generated by asymmetric information in a monopoly market.