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Consumer Frauds and the Uninformed: Evidence from An Online Field Experiment

Consumer Frauds and the Uninformed: Evidence from An Online Field Experiment

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Published by Trent Rock
Economists accept consumer frauds as an equilibrium outcome of information costs. This
paper empirically investigates what information is costly, what contribute to the information
costs, and what institutions are more effective in reducing the information costs.
Economists accept consumer frauds as an equilibrium outcome of information costs. This
paper empirically investigates what information is costly, what contribute to the information
costs, and what institutions are more effective in reducing the information costs.

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Published by: Trent Rock on Nov 02, 2010
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11/05/2011

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Consumer Frauds and the Uninformed:Evidence from An Online Field Experiment
Ginger Zhe JinAndrew KatoUniversity of MarylandMarch 5, 2004
Correspondence: Department of Economics, University of Maryland, College Park, MD 20742; phone (301)405-3484; email jin@econ.umd.edu. We benefit from comments of Austan Goolsbee, Rapheal Thomadson, JohnShea, Dan Vincent, David Reiley, Larry Ausubel, Peter Cramton, V. Joseph Hotz, Jeff Smith, Jimmy Chan,Vincent Crawford, Mark Duggan and attendants at numerous seminars and conferences. We are particularlygrateful to Seth Sanders and John List for their constructive advice at the early stage of the research, and toTimothy Bresnahan, Rachel Kranton and Thomas Hubbard for their detailed suggestions in reshaping earlierversions. Special thanks to 8 friends who acted as our agents in purchasing baseball cards in retail markets, andnumerous sports card store owners who shared their insights regarding the sportscard industry. Excellent researchassistance from Randy Alexander Moore and Krzysztof Fizyta is gratefully acknowledged. Any remaining errorsare ours.
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Abstract
Economists accept consumer frauds as an equilibrium outcome of information costs. Thispaper empirically investigates what information is costly, what contribute to the informationcosts, and what institutions are more effective in reducing the information costs.We focus on one of the most complained about markets – Internet auctions. In a fieldexperiment, we obtain actual baseball cards from both online and retail markets whosequality are then professionally graded and compared to the prices paid by online buyers forgoods with similar claims. The experiment allows us to obtain a key variable - true quality- on top of price and seller ratings used in the existing literature.Our findings indicate that some naive buyers in the online ungraded market are misled bynon-credible claims of quality. They pay higher prices but do not receive better quality andin fact are defrauded more often. In comparison, claim-driven frauds do not exist in retailor graded markets where buyers can observe card quality either through careful qualityexamination before purchase or a third-party grading service. Online seller reputation isfound to be effective for identifying good-faith sellers. But conditional on completed auctions,reputable sellers do not provide better quality. More disturbingly, the price increase frommaking non-credible claims more than compensates for the lower likelihood of sale for sellerswith low reputations.We attribute the naivete to misleading signals in the online ungraded market and twoloopholes in the eBay rating system, namely universal rating and costless switching of anony-mous identities. These loopholes reduce the precision and accessibility of seller information,and therefore add difficulties for naive buyers to become sophisticated. We also point outthat naive buyers could impose several negative externalities on the other good-faith playersin the market.
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1 Introduction
Economists accept a positive level of fraud as a result of information costs (Darby and Karni1973). If a consumer possessed sufficient knowledge of seller characteristics and the qualities of goods and services, he could not be defrauded. However, it is costly to discover these data andthe consumer must make choices based on incomplete information. Because of this, misleadingseller claims or advertising could fraudulently persuade the consumer to buy something heotherwise would not.The key questions are what information is costly, what contributes to the informationcosts, and what institutions are more effective in reducing the information costs. Most literatureinvolving uninformed buyers limits the buyer’s uncertainty to information regarding specificsellers’ characteristics. For example, though buyers may not know the quality of goods producedby a specific seller, they are assumed to so sophisticated that they know the distribution of qualityof all goods for sale in the market.
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This paper presents evidence for a more fundamental lackof information: some consumers may not even possess correct beliefs on the distributions in themarket.To distinguish these naive consumers from the traditional sophisticated but uninformedbuyers, we watched the online market for baseball cards to identify consumer behavior patternsand designed an experiment to test if those patterns corresponded to rational behavior. Aseven-month eBay observation revealed 35-52% higher prices were paid to sellers claiming to beselling high quality cards (as opposed to modest or no claims). This would be perfectly rationalif sellers making grand claims actually delivered better cards or provided more reliable service.Such was not the case.Immediately following the observation period, we purchased the same types of ungradedcards and had them professionally evaluated. These cards were systematically purchased sohalf of the sample came from high claims sellers and the other half from modest or no-claimsellers. In a reversal of the rational expectation story, sellers making the best claims were morelikely to default (no delivery) or send counterfeits. Even conditional on actual deliveries of authentic cards (as validated by the professional grading service), the average quality from highclaims sellers was no better than the average for the group with more modest claims. Further
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This assumption is explicit in Akerlof (1970), Shapiro (1983), and many follow-up papers summarized in Tirole(1988). To be precise, buyers in Shapiro (1983) are even over-sophisticated: they anticipate infinite supply of hit-and-run sellers, and therefore refuse to pay non-zero price for non-reputable sellers, although some non-reputablesellers are new honest ones. See footnote 7 for more citations on informed and uninformed buyers.
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