Economists credit ads with two welfare‑enhancing roles:
- Informative – trimming search costs (Stigler 1961 (pdf)).
- Signaling – In classic models, high-quality sellers are more willing to incur large, sunk ad costs because they expect to recoup them through future sales—especially in experience-good markets where quality is learned over time (Nelson 1974). Milgrom and Roberts (1986) formalize this idea: when ad spend is costly and more valuable to better firms, it can serve as a credible signal of quality.
Internet upended the first role—search is instant—but also weakened the second.
Five Frictions That Flatten the Signal
- Disposable brand identities
Launching a fresh storefront requires packaging, photography, and a seed set of paid or incentivized reviews; yet, those outlays are tiny relative to the lifetime margin on a successful listing. Because tarnished names can be retired cheaply, long‑run reputation no longer disciplines bad actors. - CPA pricing removes the burn
Most major ad systems now let advertisers pay only when a sale or lead occurs (Target CPA in Google Ads, Cost‑per‑Result goals in Meta’s Advantage+ campaigns, goal‑based bidding in Amazon DSP). With spending converted from sunk to variable, even low‑quality sellers can fund promotion from day‑one revenue. - Light‑touch returns & the “Frequently Returned” tag
Seamless returns cap consumer harm, but seller penalties are modest: a restocking fee, a metrics ding, or Amazon’s “Frequently Returned Item” badge—issued only after damage is done. Only the worst lemons are fully delisted, leaving plenty of mediocre goods in play. - Ratings compression
Star ratings on major platforms increasingly cluster between 4.3 and 4.9, leaving buyers little room to distinguish products. Part of this stems from review manipulation—Amazon blocked >250 million suspected fake reviews in 2023 alone, indicating the size of the problem. - Heuristic‑driven shoppers
Deprived of credible signals, buyers default to the price–quality heuristic—higher price means better goods (Monroe & Krishnan 1985). Sellers respond by listing identical inventory at staggered prices across multiple storefronts.
These frictions reinforce one another: CPA funding keeps every storefront bidding; fake reviews mask quality gaps; disposable brands dodge reputational blowback; and behavioural heuristics close the sale—locking the marketplace into what we call the grifter equilibrium.
A Sock Search in Action
Search “ankle socks” on Amazon:
- Sponsored slots dominate; brands are unfamiliar.
- Ratings hover around 4.5; product photos are interchangeable.
- Prices span a wide range without visible changes in features.
Formalising the Grifter Equilibrium
A. Setup
| Symbol | Meaning |
|---|---|
| (p) | Posted price (assumed equal across types for clarity) |
| (m_H, m_L) | Unit cost for high‑ and low‑quality goods ((m_H > m_L)) |
| (\tau) | CPA take‑rate (identical across sellers unless platform surcharges) |
| (\phi) | Probability a low‑quality sale triggers a penalty/return |
| (R) | Expected penalty per flagged lemon |
| (k) | Cost of opening a new storefront (small but positive) |
B. Per‑sale profits
$$[
\pi_H = p(1-\tau) - m_H, \qquad
\pi_L = p(1-\tau) - m_L - \phi R .
]$$
C. Advertising condition for low‑quality sellers
$$[
\pi_L > 0
;\Longleftrightarrow;
m_L + \phi R < p(1-\tau).
]$$
Ultra‑cheap production and modest penalties make this inequality easy to satisfy, so lemons advertise alongside premium goods.
D. Dynamic relaunch option
If poor feedback eventually sinks a storefront, the seller pays (R), incurs a small relaunch cost (k), and restarts the cycle. Unless (k) or (R) become large, the net present value of “being a lemon” remains positive, sustaining a pooling equilibrium in which ad spend reveals little.
Escape Hatches
Restoring signalling requires a cost that lemons cannot shirk:
- Persistent manufacturer IDs – reputation follows the factory, not the storefront.
- Return‑adjusted CPA surcharges – raise ($\tau$) when ($\phi R$) climbs.
- Escrowed ad bonds – forfeited if defect or return metrics exceed benchmarks.
- Relaunch detection – inventory‑fingerprint matching to raise ($k$).
Why the Marketplace Doesn't Implode
- Return valve caps—but doesn’t erase—consumer pain.
Generous return policies and Amazon’s “Frequently Returned Item” badge let buyers jettison the worst lemons. Hassle costs remain, but catastrophic disutility is rare. - Ultra‑low unit costs keep lemons profitable.
When socks cost $2 to make and the CPA take‑rate is 20 %, sellers can survive double‑digit return rates and still clear margin. - Heterogeneous, often low‑stakes demand.
For gym gear, kids’ camp supplies, or one‑off gadgets, shoppers accept higher quality uncertainty in exchange for speed and price, muting the penalty for mediocre goods. - Platform revenue is tied to congestion—up to a point.
Amazon collects a fee on every ad click and every sale, so a crowded, ad‑dense marketplace boosts short‑run revenue. The company does police egregious abuse to protect long‑run customer trust, but the optimal balance still tolerates a substantial volume of “good‑enough” products.
See also: https://www.gojiberries.io/optimally-suboptimal-behavioral-economic-product-features/