Introduction to Part IV: Product quality and information
So far in this book, we have mainly been dealing with search goods, that is, products or services with features and characteristics that can easily be evaluated before purchase. In contrast, this part of the book examines products and services with characteristics that can only be ascertained upon consumption because they are difficult to observe in advance. We talk here of experience goods.
Managing experience goods is the day-to-day concern of large firms selling consumer goods, such as Nestlė Procter&Gamble or Unilever. These firms frequently introduce new branded products. They are always interested in not only making consumers aware of the product (e.g., through advertising as we have analysed in Chapter 6) but also convincing consumers that the new product satisfies their wants. Perhaps the main challenge when launching a new product is that consumers do not observe the quality of the product, as is typically the case with experience goods. Similarly, firms that enter an otherwise perfectly competitive industry with a patented product (or, alternatively, open new markets with a proprietary technology) often produce an experience good.
These markets are characterized by asymmetric information as consumers have less information than the producers about product quality. In such markets, firms have to convince consumers that their products are of high quality. To this end, firms can use a variety of marketing instruments. This is the topic of the following two chapters. We mostly focus on markets in which a single firm has market power; situations in which multiple firms have market power are more challenging and will not be analysed systematically in this context.
In Chapter 12, we analyse the basic problem of asymmetric information. Adverse selection may lead to a breakdown of quality in the market. If a firm has initially to invest in quality, the effect of asymmetric information on quality provision is ambiguous. In response to an asymmetric information problem, the firm may also choose from an arsenal of marketing devices. Here, we focus on price and advertising signals of quality, both in isolation and in combination.