Markets with untraceable goods of unknown quality: Beyond the small-country case

Abstract

When importing durables and nondurables, consumers often cannot discern quality prior to purchase. If they cannot also identify the individual producer, exporters have diminished incentives to produce high quality goods. To raise the quality of traded experience goods, previous international literature has proposed consolidation of export firms and the imposition of export quotas, policies that may be appropriate for tiny Taiwan but not a colossus like China. We contribute to this literature in three ways. First, we explicitly model the way in which consumers of experience goods rely on the reviews of previous buyers (who in turn rely on the reviews of buyers before them...) when deciding whether to purchase an experience good. Second, we endogenize the price of any given quality. Third, we assume that firms may exercise market power. As we show, once the "small country" assumption is dropped, policies advocated in the literature such as the merger of exporters or the imposition of export quotas can have adverse consequences on the profits of domestic exporters and on the welfare of all consumers. On the other hand, the unilateral imposition of minimum quality standards will increase the profits of domestic exporters while improving the welfare of all consumers.