Monopoly, Product Quality, and Flexible Learning

Abstract: A seller offers a buyer a schedule of transfers and associated product qualities. After observing this schedule, the buyer chooses a flexible costly signal about his type. We show it is without loss to focus on a class of mechanisms that compensate the buyer for his learning costs. Using these mechanisms, we prove that when marginal costs of quality are strictly increasing, quality always lies strictly below the efficient level at all types strictly below the highest possible type under the prior. When learning costs are sufficiently steep, it follows the monopolist optimum distorts quality downward even "at the top" of the buyer's chosen signal structure. Moreover, when marginal costs of quality are constant, interior buyer types obtain interior qualities. These results stand in contrast to the exogenous information case, which features "no distortion at the top" when marginal production costs are increasing, and serving the maximal quality to all types above some threshold when marginal product costs are constant. We also show that when learning costs are steep, the monopolist finds it optimal to offer a simple menu that contains at most two purchasing options. Under appropriate curvature conditions, offering a single purchasing option is optimal.