Expanding the Informativeness of the Price System with Law

We Consider in This Paper the Revelation of Quality Through Prices in a Competitive Equilibrium When the Consumers, Which Are All Similar, Do Not Observe Quality Before Buying But Have Rational Expectations About It Conditional on the Price They Observe. We Are Particularly Interested by the Emergence of Fraud in a Rational Expectations Competitive Equilibrium, That Is by the Possibility That Firms Will Sell a Low Q Quality Product While Announcing It As a High Quality Product. We Explicitly Consider the Cost of Fraud in the Form of a Legal Penalty to Be Paid, But Only If Someone Is Convicted of Fraud; Firms Selling the Low Quality Good Will Differ Across Their Probability of Conviction If They Engage in Fraud.