Product Quality, Informational Efficiency, and Regulations in Experimental Markets

Abstract

This study reports on the behavior of experimental markets in which product \nquality is endogenously determined and cannot be observed by buyers prior to \npurchase. Several theories suggest that with asymmetric information about product \nquality between buyers and sellers and the absence of properly defined rules \nof liability, markets cannot be expected to generate products of "optimal grade." \nAccording to such theories markets will be informationally inefficient. Information \nthat exists will not be properly used because the wrong people have it. As a \nresult, products that can be cheaply produced but are of undesirable quality \n("lemons") will drive good grade products from the market because buyers \nwill be improperly informed at the time of purchase. However, very little noncontroversial evidence exists regarding the proposition. Several modes of \nbehavior and institutions can theoretically intervene to mitigate the problems. In \naddition, theories are hard to test because measurements of preferences, cost, \nknowledge, and so forth, of sufficient precision to determine whether a market \nhas "failed" are difficult in naturally occurring environments. The markets we \ncreated and studied have fewer such complications.

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