Quality is in the Eye of the Beholder: Taste Projection in Markets with Observational Learning

Abstract

We study how misperceptions of others’ tastes influence beliefs, demand, and prices in markets with observational learning. Consumers infer the commonly-valued quality of a good from the quantity demanded and price paid by others. When consumers exaggerate the similarity between their and others’ tastes, such “taste projection” leads to discrepant quality perceptions across consumers. A projector’s (mis)inferred quality is negatively related to their taste and increasing in the observed price. These biased beliefs generate an excessively elastic market demand. We also analyze dynamic monopoly pricing with short-lived taste-projecting consumers. Optimal pricing follows a declining path. The seller uses a high price early to inflate future buyers’ perceptions, and then lowers it gradually to induce over-adoption.