Imagine a situation where you are thinking of buying a good and so you go to an e-commerce marketplace such as Amazon, eBay, Etsy or Onbuy. How confident are you about the quality of the different brands/makes that are listed for sale on these digital platforms? How do you choose which product to buy? Is the decision strongly influenced by customer reviews and rating?
When a customer is choosing what to buy it raises an interesting question: to what extent can the true quality of the different goods/services be observed at the time of purchase? Although perfect observability is highly unlikely, the level of consumer information about a product’s true quality will vary between different types of transaction.
For example, when consumers can physically inspect and test/try a product in a shop, it can help them to make more accurate judgements about its quality and condition. This poses a problem for online sellers of high-quality versions of a good. Without the ability to inspect the item physically, consumers may be unsure about its characteristics. They may worry that the online description provided by the seller deliberately misrepresents the true quality of the item.
Consumers may have other concerns about the general reliability of online sellers. For example, in comparison to buying the product from a physical store, consumers may worry that:
- They will have to wait longer to receive the good. In many cases, when consumers purchase a product from a high-street store, they can walk away with the item and start using it straight away. When purchasing on line, they may end up waiting weeks or even longer before the product is finally delivered.
- It will be more difficult to return the product and get a refund.
- They are more likely to come across fraudulent sellers who have set-up a fake website.
This greater level of uncertainty about the true characteristics of the product and the general reliability of the seller will have a negative impact on consumers’ willingness to pay for all goods. This impact is likely to be particularly strong for high-quality versions of a product. If consumers’ willingness to pay falls below the reservation price of many sellers of high-quality goods, then the market could suffer from adverse selection and market failure.
Are there any within-market arrangements that could help deal with this issue? One possibility is for sellers to signal the quality of their products by posting consumer ratings and reviews. If consumers see that a product has many positive ratings, then this will increase their confidence in the quality of the product and so increase their willingness to pay. This could then reduce both levels of asymmetric information and the chances of adverse selection occurring in the market,
There is survey evidence that many people do read consumer reviews when choosing products on line and are heavily influenced by the ratings.
The problem of fake reviews
However, when consumers look at these reviews can they be sure that they reflect consumers’ honest opinions and/or actual experience of using the good or service? Firms may have an incentive to manipulate and post fake reviews. For example, they could:
- Deliberately fail to display negative reviews on their website while claiming that all reviews are published.
- Use internet bots to post thousands of automated reviews.
- Take positive reviews from competitors’ websites and post them on their own website.
- Pay some customers and/or employees to write and post 5-star reviews on their own website.
- Pay some customers and/or employees to write and post 1-star reviews on their competitors’ websites.
- Set up a website that they claim is independent and use it to provide positive endorsements of their own products.
If the benefits of this type of behaviour outweigh the costs, then we would expect to see fake reviews posted on websites. If their use becomes widespread, then the value of posting genuine reviews will fall. The market may then settle into what economists call a ‘pooling equilibrium’.
What evidence do we have on the posting of fake reviews? Given their nature, it is difficult to collect reliable data and there are large variations in the reported figures. One recent study found evidence of fake reviews being purchased and posted for approximately 1500 products on Amazon.
Can consumers screen reviews and identify those that are more likely to be fake? The following are some tell-tale signs.
- Products that receive a large number of very positive reviews over a short period (i.e. a few days). There are then long periods before the product receives another large number of positive reviews.
- A high percentage of 5-star reviews. Two, three and four start reviews are more likely to be genuine.
- Reviews that specifically mention a rival firm’s products.
- Reviewers who have given very high ratings to large number of different products over a short period of time.
- Reviews that include photos/videos.
Competition authorities around the world have been investigating the issue and the Competition and Markets Authority has announced plans to introduce new laws that make the purchasing and posting of fake reviews illegal.
- Outline different types of asymmetric information and explain the difference between adverse selection and moral hazard.
- Using a diagram, explain the impact of uncertainty over the quality of a good on consumers’ willingness to pay.
- Will consumers always face greater uncertainty over quality when purchasing goods on line rather than visiting the high street? Discuss your answer making reference to some specific examples.
- Using diagrams, explain how a market for high-quality versions of a good might collapse if there is asymmetric information. Using price elasticity of supply, explain the circumstances when the market is more likely to collapse.
- Discuss some of the benefits and costs for a firm of purchasing and posting fake reviews.
Merlin Entertainments PLC is one of the largest operator of visitor attractions in the world and owns over a third of the most popular theme parks in Europe. It runs the four most visited parks in England – Alton Towers, Legoland Windsor, Thorpe Park and Chessington World of Adventures as well as the most popular theme park in Italy – Gardaland. Alton Towers alone had 2.5 million visitors in 2013. Anybody thinking of going to one of these attractions is faced with a wide range of different entry fees .
Theme parks and tourist attractions have market power so their owners have to make some interesting pricing decisions. They have to tackle the same dilemma that confronts any seller that faces a downward sloping demand curve for its goods/services.
One option for the firm would be to increase the entry fee. This would produce higher profits per visitor as some of the surplus from the transaction previously enjoyed by the consumer will be extracted by the seller and converted into producer surplus. Unfortunately for the business the higher price, all other things equal, will also result in fewer visitors. Some people will be deterred from visiting because of the higher price and the seller will lose out on potential revenue.
An alternative strategy would be for the theme park to reduce its entry fee. All other things equal, this will increase the number of visitors. However, it would also mean that the profit per customer would fall. The frustrating issue for the seller is that some of its customers, who would still have visited the attraction at the higher price, are now able to get a better deal.
This dilemma exists if the seller has to charge all of its different customers the same entry fee. If it could charge a higher entry fee to those customers who would be willing to pay more and a lower entry fee to those who would be willing to pay less then it could make more money. Extra revenue could be obtained from those additional sales that take place at the lower price while more consumer surplus could be extracted from those still paying the higher price.
Is it possible for a firm to charge different prices to different customers for the same or a similar good or service? Table 1 below shows the entry fees for Warwick Castle, another tourist attraction owned by Merlin Entertainments PLC.
It can immediately be seen from this table that some groups of customers pay a different entry fee from others. For example adults have to pay £24 to enter on the day while people aged 60 and over pay a lower price £16.80. The entry fee for children aged between 4 and 11 is £21.00 while those aged 3 and under go for free. Students aged 16-18 can gain entry for a price of £13.50 if they can provide valid ID and purchase the tickets from the visitbritainshop website.
In this example, the company has allocated people into different categories by age (i.e. senior, adult, student, older children and younger children) and has set the entry fee that customers in each group have to pay.
The table also shows that if customers purchase on- line then they can get the tickets more cheaply. The entry fee for each category is 25% lower if the ticket is booked seven days in advance i.e. the prices shown in the last column in the table. If the booking is made between 2-6 days in advance then the discount is only 10% i.e. an adult ticket would cost £21.60. The on-line discounts are open to everyone. People are given the choice to either book on-line in advance or pay on the day. This is different from a situation where you are placed into a category by the firm. For example the customer cannot choose whether they are over 60!
If people are prepared to spend more time searching on the internet then other cheaper prices can also be obtained. Once again these offers are open to anyone willing to spend the time and effort in order to find them.
All the ticket prices above give people access to exactly the same attractions on the day. They do not give the visitor access to two of the attractions at the castle – the Dragon Tower and Castle Dungeon. Entry to the Dragon Tower would cost an adult on the day an extra £1.80 while entry to the Castle Dungeon would cost an extra £5.40.
Warwick Castle Ticket Prices Warwick Castle (accessed on 04/09/14)
Alton Towers Alton Towers (accessed on 08/09/14)
Warwick Castle Tickets visitbritainshop (accessed on 02/09/14)
Global Attractions Attendance Report teaconnect (accessed on 05/09/14)
Merlin Entertainments Merlin Entertainments (accessed on 08/09/14)
- What pricing decisions do firms have to make if they operate in a perfectly competitive market?
- Explain why an individual tourist attraction will have a downward sloping demand curve
- Paying an entry fee and an extra payment per attraction is known as what type of pricing? What advantages does this type of price strategy have for the seller?
- How would you calculate the profit per customer? What factors other than the entrance fee would determine the profit made per customer in a theme park or tourist attractions?
- Paying a different price depending on which category you have been assigned to by the seller is known as what type of pricing strategy? Can this type of pricing strategy ever be in the interests of society?
- In the example used in the case, customers are assigned to different categories by age. Can you think of any other ways that firms could categorise their customers?
- Given the category customers have been assigned to they can pay different prices depending on whether they buy the tickets on line. What is the price strategy called when customers can choose from a variety of pricing options for the same or similar product? Can you think of any different methods that could be used by the seller to carry out this type of pricing strategy?
In the blog A surprising rise we analysed the recent trends in the housing market. In August house prices increased the fastest since January 2010 and this left the average UK house price at just under £165,000.
Whilst this has still meant getting on the property ladder is only a dream for many, for those wishing to buy in London, they will, on average, need to find £368,000. London wages are significantly higher than in the rest of the country, so it is hardly surprising that average house prices are too.
However, an average London wage won’t get you close to the following property! With a reported asking price of £300m, it would be the highest priced house ever sold in London. Undoubtedly, you get a fair amount for your money, including 45 bedrooms and 60,000 square feet, but is this worth £300m? A property expert believes that it will be sold privately, not publicly, as it is such a rare property and that naturally, there will only be a few potential buyers!!
So, who are the likely buyers? You won’t be able to walk into a local estate agent and ask for a viewing. Only certain people with the funds to spare are being offered it. Many foreigners have been purchasing property in London, looking for a safe investment, with the trouble in Europe. This has led to London property prices rising very rapidly. But surely £300m is a little over the top! Assuming the asking price is paid, in order for a potential buyer to get any consumer surplus, he or she would have to value the property at significantly more than £300m – especially as stamp duty of approximately £21m would have to be paid.
The following few articles look at this record property price. (By the way, the house in the picture at the top of this blog is not the house that’s for sale: it’s a girls’ school in Tetbury. I don’t know how much it’s worth!)
London’s most expensive house yet, at £300m? BBC News, Ian Pollock (13/9/12)
London mansion on sale for record £300m Telegraph, Matthew Sparkes (13/9/12)
Money’s not too tight for buyer of £300m London mansion Guardian, Esther Addley and Yasmin Morgan-Griffiths (13/9/12)
- Why are property prices in London so much higher than in other parts of the UK?
- Why is this property being sold privately not publicly, when selling publicly typically gains a higher price?
- How would an individual place a value on this property?
- What is consumer surplus and how would an individual calculate it?
- Could this record price for the property have a positive or adverse effect on property prices in other parts of London?
- Why is mortgage rationing unlikely to be a concern for this property!