Equilibrium Analysis of Unfair Competition From Shoddy Goods

Abstract

Advances in e-commerce allow consumers to learn the truth about shoddy goods. This article develops an analytical framework for examining the competition between an honest manufacturer (the “truth-teller”) and a deceptive manufacturer (the “deceiver”). Our equilibrium analysis suggests that the deceiver is not always inclined to deceive and that the truth-teller is not necessarily harmed by deception. Depending on the parameter values, the deceptive behavior of a deceiver can lead to four types of outcomes vis-à-vis the truth-teller: win–win, win–lose, lose–win, and lose–lose. In particular, if the consumer response to deception is weak then the truth-teller always has an incentive to prevent the deceiver from excessively exaggerating its product quality by lowering his own production cost, which lessens the truth-teller's deceiver-induced profit loss. Yet if the consumer response to deception is strong then the truth-teller can prevent the deceiver from even slightly exaggerating its product quality by raising his own production cost; however, he might not have sufficient incentive to do so because this strategy would reduce his profit. Counter-intuitively, if the consumer response to deception is weak, then both consumer surplus and social welfare will actually increase with the deceiver's announced quality.