Equilibrium Analysis of Unfair Competition from Shoddy Goods: The Role of Consumer Behavior

Abstract Advances in e-commerce allow consumers to learn the truth about shoddy goods. This paper develops an analytical framework~-- for examining the competition between an honest manufacturer (the ''truth-teller'') and a deceptive manufacturer (the ''deceiver'')~-- that incorporates three aspects of consumer behavior:\ perceived utility, negative word-of-mouth (WOM), and aversion. Our equilibrium analysis suggests that a truth-teller's lowered production cost can reduce deception-related losses by discouraging the deceiver from excessively improving its product quality; however, the truth-teller's own excessive improvement of product quality would actually benefit the deceiver when consumers (wrongly) perceive the deceiver's products to be of high quality. Finally, a truth-teller can deal with a deceiver's unfair competition by facilitating the dispersion of early-bird consumers' negative WOM and/or by increasing late-arriving consumers' aversion to deception beyond a certain threshold. Otherwise, the truth-teller should notice that increased dispersion and aversion will give the deceiver a free ride on his reduced production cost. In particular, if the consumer response to deception~-- a combination of the dispersion of negative WOM and the aversion 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 production cost; then the truth-teller's deceiver-induced profit loss would be reduced. However, if the consumer response to deception is strong, though the truth-teller can completely prevent the deceiver from exaggerating its product quality by raising his own production cost, he might not have sufficient incentive to do so since this strategy would reduce his own profit.