TITLE:
Imperfect Quality Certification in Lemons Markets
AUTHORS:
Birendra K. Mishra, Ashutosh Prasad, Vijay Mahajan
KEYWORDS:
Product Quality, Certification, Report Verification, Grading, Information Asymmetry
JOURNAL NAME:
Theoretical Economics Letters,
Vol.10 No.6,
December
15,
2020
ABSTRACT: In markets with information asymmetry, the seller of
a high-quality product is unable to credibly communicate its quality to buyers
and is forced to price like an average quality seller. This is a disincentive
to provide quality and high-quality sellers may exit the market. Of several
methods to reduce information asymmetry, we provide an analytical study of
certification or grading of quality levels by infomediaries. In the equilibrium
of a quality reporting game, we find that certification reduces, but does not
eliminate, the problems of information asymmetry. There exists a threshold,
determined by the accuracy of the certification process, below which customers
should believe quality reports, but disbelieve reports above it. We further
examine a two-category scheme of high/low quality certification and discuss the
design of certification grades using an entropy approach.