Working Paper No. 2008 | 02
Imperfect Signals and Product Safety Disclosure: A Shepherd's Dilemma
by Glenn Sheriff (International and Public Affairs) and Daniel Osgood (International Research Institute on Climate and Society)
This paper studies dynamic markets where product safety is unobserved by consumers. Perfect, but costly, audits and an exogenous noisy signal can provide information regarding seller type. Without the noisy signal, sellers do not disclose product safety without auditing. If audits are too expensive, a pooling equilibrium can result in consumption of unsafe goods. Even a noisy quality signal perfectly identifies unsafe goods by giving sellers incentives to disclose type without audits. Introducing a signal helps buyers, but its effect on sellers is ambiguous. Even if sellers benefit, they always suffer from increases in precision.
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