Consumer Choice and Market Outcomes Under Ambiguity in Product Quality

Facing purchase choice involving ambiguity in product quality, consumers behave in a boundedly rational manner. Consumers also exhibit varying degrees of predisposition toward a product. We present a simple model of boundedly rational choice under ambiguity. The model's key feature is that it captures the interaction between predisposition and ambiguity. We build on the choice model to derive demand curves and the unique equilibrium market outcomes (regarding prices, profits, and market shares) under duopolistic competition. In equilibrium, market shares are proportional to prices. In symmetric competition, higher equilibrium prices obtain when the ambiguity in product quality is high or when the customer base is partisan. For vertically differentiated products, the strategy of a higher-quality firm to marginally reduce ambiguity depends on the ambiguity level inherent in the product-market environment. The presence of informed customers may increase the equilibrium prices and profits of both firms. An understanding of the predisposition-ambiguity interaction may improve the firm's information and brand management strategy.