Welfare-Improving Cascades and the Effect of Noisy Reviews

We study a setting in which firms produce items whose quality is ex-ante unobservable, but learned by customers over time. Firms take customer learning into account when making production decisions. We focus on the effect that the review process has on product quality. Specifically, we compare equilibrium quality levels in the setting described above to the quality that would be produced if customers could observe item quality directly. We find that in many cases, customers are better off when relying on reviews, i.e. better off in the world where they have less information. The idea behind our result is that the risk of losing future profits due to bad initial reviews may drive firms to produce an exceptional product. This intuitive insight contrasts sharply with much of the previous academic literature on the subject.