The quality guaranteeing price with market anonymity

When the information of buyers and sellers regarding the quality of a good is asymmetric, the threat of terminating a cheating seller can assure performance (Klein and Leffler 1981], Telser 1980]). However, except in very small markets, this threat is impossible to implement. The reason is that beyond a certain market size anonymity sets in: The personal identities of agents are no longer always known. Thus, although cheating firms could still be terminated, their owners could not. The most severe threat that is available to the buyer when there is anonymity is to terminate the cheating firm. But because a cheating owner could either reenter the same industry (by starting a new firm), or enter another industry that offered similar rents, the effectiveness of this threat depends on the size of the market: In a large market the probability that a new firm will get buyers is small, and with a sufficiently high price not cheating would be more profitable than cheating and trying ro reenter. In a market of only a medium size, however, the probability of successful reentry may be so high that cheating would dominate not cheating for any price that is below the buyers' reservation price. For markets with asymmetric information market size is, therefore, of crucial importance, and this is the first question that this paper deals with. The model that the paper develops determines both the minimal market size that is necessary to prevent market failure, and the actual market size that will endogenously emerge. If entry costs were very high, however, not cheating would dominate cheating regardless of the size of the market. Could “artificial” entry costs be created in order to deter cheating when there is anonymity? This is the second issue that the paper will address.