Richard Lethin, Reputation Technologies, Inc.
Reputation is the memory and summary of behavior from past transactions. In real life, we use it to help us set our expectations when we consider future transactions. A buyer depends on the reputation of a seller when he considers buying. A student considers the reputation of a university when she considers applying for admission, and the university considers the student’s reputation when it decides whether to admit her. In selecting a candidate, a voter considers the reputation of a politician for keeping his word.
The possible effect on one’s reputation also influences how one behaves: an individual might behave properly or fairly to ensure that her reputation is preserved or enhanced. In situations without reputation, where there is no prospect of memory after the transaction, behavior in the negotiation of the transaction can be zero-sum. This is the classic used car salesman situation in which the customer is sold a lemon at an unreasonable price, because once the customer drives off the lot, the salesman is never going to see her again.
A trade with a prospective new partner is risky if we don’t know how he behaved in the past. If we know something about how he’s behaved in the past, and if our prospect puts his reputation on the line, we will be more willing to trade. So reputation makes exchange freer, smoother, and more liquid, removing barriers of risk aversion that interfere with trade’s free flow.