Monopolistic Competition with Experience Goods

Abstract

This paper constructs a model of monopolistic competition where consumers cannot directly verify product quality prior to an initial purchase. Instead, consumers base initial purchases on observed prices, which perfectly signal firms' qualities both in and out of equilibrium. Equilibrium quality is less than efficient, but generally bounded away from the minimum quality. With free entry, observable product variety exceeds what would prevail with perfect information. As repeat purchases become large relative to initial purchases, or as firms become small relative to the size of the market, equilibrium product quality rises, and the market converges to the full information equilibrium.