Quality-Adjusted Consumer Surplus for Markets with Asymmetric Information

When product or service quality cannot be well-specified ex-ante because of uncertainty and information asymmetry, consumer surplus (CS) is not well-defined or known ex-ante. Traditional measures of CS have implicitly assumed that the quality expected is the same as the quality that is paid for. However, when the service and price exchange doesn’t take place at the same time and in the presence of information asymmetry, the expected service quality may not necessarily realize, which may either over-estimate or under-estimate its real level, thus misrepresenting the surplus e-markets offer to customers (service buyers). In this paper, using global e-markets for services outsourcing as a context, we propose a quality-adjusted measure for CS. We first relax the assumption that buyers always get what they expected. Second, we include the psychological factors of disconfirmation on satisfaction to construct the functional form for the measure. We leverage expectation-confirmation theory to theorize the way expected service quality and ex-post consumer satisfaction affect CS and derive a quality-adjusted measure for CS. Empirically, using transaction data from a leading e-market for services outsourcing, we find the following: First, the quality-adjusted measure of CS for the initial project of a buyer predicts whether he decides to stay on the marketplace, and even his subsequent payments and projects; while the traditional measure of CS does not have prediction power. Second, we propose the difference between the quality-adjusted measure and traditional measure of CS (delta CS) to be an indicator of ex-post differential satisfaction, and find buyer experience, repeat purchase, lack of language barrier and labor arbitrage to be positively associated with , while number of bids is negatively associated with delta CS. Third, the results also show that buyers reap an average surplus of $94.4-$175.5, even the lower-bound estimate is surprisingly high (about 69% of the winning bid price ($137)). Also, providers’ CS will be inflated if the quality-adjusted measure is not employed. We discuss validity of the quality-adjusted measure of CS and call for revisiting the estimation of CS toward economic reality