Price Signaling and Channel Coordination

Abstract

When information asymmetry exists in the market, firms often use the price signal to communicate unobservable quality to consumers. We examine the signaling role of retail price in a decentralized channel. Our normative model demonstrates that there might exist a moderate range of retail prices (we term this range the “quality suspicion range”) within which consumers cannot perfectly discern quality from the price. In order to credibly communicate high quality to consumers, the retailer is forced to set a price either below or above the quality suspicion range. This handicaps the retailer’s price response to wholesale price. We find that there could exist equilibria such that the wholesale price is relatively low (and the retail price is compelled to be correspondingly low). The low prices reduce channel inefficiency due to the double marginalization. As a result, consumers, retailers and manufacturers might all be better off under imperfect than perfect information.

Keywords: channel coordination, signaling, pricing, game theory

JEL Classification: D82, M31