Consumer Protection in Markets with Informationally Weak Buyers

Abstract

Resource allocation in a market where product quality is variable and where buyers can purchase partial information on product quality is investigated. It is shown that (1) (inefficient) equilibria with only low quality units can always exist; (2) (efficient) equilibria with only high quality units are possible only under surprisingly strong information conditions; and (3) (<mixed equilibria, in which both high and low quality units are produced and sold and in which buyers obtain partial unit-specific quality information, can also exist. The implications of the results for (potentially) efficiency-increasing regula? tion are discussed. ? Calls for consumer protection legislation are often motivated by a claim that buyers are in some sense weaker than sellers in marketplace dealings. Given such weakness, active consumer protection might be deemed desirable either as a device for increasing equity among buyers and sellers or as a method for improving the allocational efficiency of markets. In this article, I shall examine the efficiency motive for consumer protection when buyer weak? ness is interpreted to mean that buyers have poorer, or more costly, informa? tion on product quality than sellers. The general view taken here is that frictions, such as asymmetrical informa? tion on product quality, can reduce economic efficiency from a hypothetical first-best level, but that some allocational efficiency may be restored through legal intervention. Akerlof (1970) was the first to analyze asymmetrical informa? tion. He showed that if sellers know the quality of the goods they offer, but buyers know only the average quality of all goods offered in the market, then a breakdown of market efficiency can occur whereby units of high quality will not be traded in equilibrium. In the present article, Akerlof's view of asymmetri? cal information is generalized to include two elements relevant to the economics of consumer protection. First, in contrast to Akerlof's analysis where the existence of goods of different qualities was taken as a datum, production is admitted here. This allows us to evaluate whether asymmetrical information can cause the wrong goods to be produced, a matter which is of interest,