Reputation Building under Observational Learning

A patient seller interacts with a sequence of myopic consumers. Each period, the seller chooses the quality of his product, and a consumer decides whether to trust the seller after she observes the seller's actions in the last K periods (limited memory) and at least one previous consumer's action (observational learning). However, the consumer cannot observe the seller's action in the current period. With positive probability, the seller is a commitment type who plays his Stackelberg action in every period. I show that under limited memory and observational learning, consumers are concerned that the seller will not play his Stackelberg action when he has a positive reputation and will play his Stackelberg action after he has lost his reputation. Such a concern leads to equilibria where the seller receives a low payoff from building a reputation. I also show that my reputation failure result hinges on consumers' observational learning.

Automated summary

Under limited memory and observational learning, consumers are concerned that the seller may not take the Stackelberg action when his reputation is good, but will take it after losing his reputation. Such concern results in low payoff for the seller in reputation building. The reputation failure is influenced by consumers' observational learning.