Well, in fact it is not a piece of news. It is the title of a paper I wrote last winter. After finishing it, I went on doing something else and forgot it. Now it is already a new spring, I do not want to submit it to any journals since I have nothing fresh to add into it. Without anything new, I don't have the incentive to edit it. Therefore, I share it with you here.

Title

What Do We Pay For Asymmetric Information? The Mechanism Evolution of Reputation, Punishment and Barriers to Entry in Online Markets

Abstract

The appearance of the Internet reduces transaction costs greatly, and brings the boom of online markets. While we are trying to regard it as the most realistic approximation of perfect competition market, the asymmetric information and a series of problems caused by it stop us from dreaming. As the old saying goes, there is no free lunch. This summer witnessed the collapse of the reputation system in Taobao, the biggest online transaction website in China. In fact, during the evolution of mechanisms in online markets, reputation, punishment and barriers to entry have been established in turn. What do we pay for maintaining these mechanisms? In which circumstance will they be effective?

In this paper I try to build a series of models within the principal-agent framework and repeated games to explain why and what we should pay for asymmetric information while enjoying shopping online. Specifically, these mechanisms are considered step by step and their boundary validation conditions are discussed. Finally, as the conclusion indicates, in a larger range that a mechanism is effective, the more opportunity cost should be paid as a rent for information.

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Related Researches

A lot of previous papers have discussed the asymmetric information problem in online markets, as well as more empirical researches. As Greif (1993) indicates, the change in contract forms will have a remarkable influence on economic development. Many western researchers have focused on the pricing mechanism (Avery et al. , 1999), the function of reputation mechanism in online auction (Cabral &Hortacsu, 2004; Bajari & Hortacsu, 2003), and the reduce of search cost in the Internet (Bakos & Yannis,1997; Johnson et al. , 2004). For the mechanism of reputation, Stiglitz & Weiss (1981) analysised the mortage system in asymmetric information; David & Robert(1982) provided a model in traditional markets; Shapiro (1983) indicated the existing of price premium for high reputation sellers. However, no former research has discussed about the circumstance in which the mechanism will necessarily be effective and compare the mechanisms together to find out the changes in social welfare under every mechanisms.

Some empirical researches are based on the view of mechanism design (Bajari & Hortacsu, 2003;Trifts, 2000). Specifically, for reputation mechanism, Ba & Pavlou (2002) took the consumer’s feedback into account and verified the positive price premium; Livingston (2005) uses a dynamic game model to test the Ebay auction market. Other researchers use experimental economic methods to test the validation of each mechanism. But seldom of them pay attention to the characteristics of available online transaction data. I will introduce the high-frequency econometric method to make the empirical result more reliable. Moreover, most of them ignore the nature of different categories of goods, so they failed to examine the punishment and barriers to entry mechanism. I will make a entire comparison to test my theoretical model carefully.

Structure

• First, in the theoretical part, I will try to build a series of models within the principal-agent framework and repeated games to explain why and what we should pay for asymmetric information while enjoying shopping online. Specifically, these mechanisms are considered step by step and their boundary validation conditions are discussed to explain how the truth violates these conditions.
• Next, in the empirical part the data are collected via Taobao's public API (Application Programming Interface), and I'll use high-frequency econometric methods to test the effectiveness of this theoretical model.
• Furthermore, in the last part I will make a comparison to traditional markets in a historical approach. The nature of online markets is similar to the traditional ones except the way and speed of transiting information, and the reason why I am interested in online markets is that it is an approximation of perfect competition markets existing in the real world. In this case, a comparison to the evolution history of traditional market may be revealing.

Conclusions

According to my theoretical models, all of these three mechanisms will be effective in particular environments. A stimulative result of valid areas is shown below:

However, with the interruption of some “noise” or baleful actions, the mechanism of barriers to entry is the only left choice for market designers to use, because it reduces the level of competitiveness as well as consumer's welfare.

In addition, with the compassion to traditional markets.....the empirical results also....[To be finished...]

Furthermore, when paying attention to price-determine principles, the consumer should either pay premiums for High-Reputation sellers or make an effort to identify the quality, or even both. The situations of consumer's welfare (given a certain budget) are shown in the following figure (one shadow area represents one mechanisms).

Therefore, the existing of these mechanisms that enables the normal order of the market has actually caused an opportunity cost. So the significance of mechanism design to economic activities can be interpreted clearly.

While the development of science and technology is making our everyday lives better with new innovative applications, it is necessary to find out how the information will influence microeconomic activities. Does it really reduce the level of asymmetric information? What is their influence on contracts and the determination of price? The online market is a ideal ground to test the effectiveness of different mechanisms and find out their opportunity costs. Thus, the combination of theoretical models and experimental applications is the direction of future research.