Experience Goods: Primary Markets.
Consumers can determine the qual ity of experience goods with certainty only through consumption. must search costs, Cs, and the fu price plus the ex pected loss of failure or damage collateral with consumption) The full price of con suming a meal at an unfamiliar restaurant, for instance, is the sum of purchase price (determined from the menu) and the expected cost of any adverse health effects (ranging from indigestion to poisoning) from the meal being defective Of course even when the expected collateral loss is zero, prior to consumption, the marginal value that the consumer places on the meal is not known with certainty. In contrast to search goods, where, holding search costs constant, consumers optimally take larger samples for more goods, they take s er samples for more expensive experience Indeed, for the inex all but pensive experience goods, we expect sampling (equivalent to the frequency of purchase for experience governed primarily by durabil desirable restaurants will generally be more frequent than sampling to find good used automobiles As is the case with search goods, the more heterogeneous the quality of an experience good, the greater is the potential for inefficiency due to information asymmetry. The consumption of an experience good, however, may involve more than simply forgoing a more favorable purchase of the good. Once consumption re veals quality, the consumer may discover that the good provides less marginal value than its price and therefore regret having made the purchase regardless of the availability of alternative units of the good. The realized marginal value may actu ally be negative if consumption causes harm. Learning from the consumption of experience goods varies in effectiveness. Learning from the consumption of experience goo varies in effectiveness If the quality of the good is homogeneous and stable, then learning is complete after the first consumption-consumers know how much marginal value they will derive from their next purchase, including the expected loss from product failure or collateral damage. If the quality is heterogeneous or unstable, then learning pro- ceeds more slowly. Unless consumers can segment the good into more homoge- neous groupings, say, by brands or reputations of sellers, learning may result only in better ex ante estimates of the mean and variance of their ex post marginal val- uations. When consumers can segment the good into stable and homogeneous groupings, repeated sampling helps them discover their most preferred sources of the good in terms of the mean and variance of quality, For example, national motel chains with reputations for standardized management practices may provide trav- elers with a low-variance alternative to independent motels in unfamiliar locales In what situations can informative advertising play important role in re ducing information asymmetry? informative advertising can effec tive when consumers correctly believe that sellers have a stake in maintaoning reputations for providing reliable information. who invests in favorable reputation is provide accu useful information than unknown selling a new an individual owner house or used automobile. When consumers perceive that sellers do not have a stake in maintaining a good reputation, and marginal cost of supply rises with quality, then "lemons problem may arise: consumers perceive a full price based on average quality so that only sellers of lower than average quality goods can make a profit and sur vive in the market.35 In the extreme, producers offer only goods of low quality 39 When reliability is an important element of quality, firms may offer warranties that promise to compensate consumers for a portion of replacement costs, collateral damage, or both. The warranties thus provide consumers with insurance against low quality: higher purchase prices include an implicit insurance premium, and the po tential loss from product failure is reduced. The quality of a warranty may itself be uncertain, however, if consumers do not know how readily firms honor their promis es. Further, firms may find it impractical to offer extensive warranties in situations where it is costly to monitor the care taken by consumers. Nevertheless, warranties are a common device for reducing the consequences of information asymmetry fo experience goods.