Prices as Signals of Product Quality in a Duopoly
29 Pages Posted: 30 Jun 2020 Last revised: 9 Mar 2021
Date Written: June 7, 2020
In a duopoly model of horizontal and vertical differentiation, where consumers are ex-ante unaware of product qualities, we study the firms' incentives to signal quality via prices. Consumers, after they observe prices, can evaluate a firm's product quality before purchase if they incur a search cost. We show that a complete information (undistorted) separating equilibrium and a unique pooling equilibrium (in pure strategies) exist. A lower search cost moves the market equilibrium from pooling to separating and induces a mean-preserving spread in the distribution of the equilibrium prices.
Keywords: Consumer search, Product quality, Signaling
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