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Imperfect Competition and Quality Signaling

39 Pages Posted: 26 Jul 2005  

Andrew F. Daughety

Department of Economics, Vanderbilt University; Vanderbilt University - Law School

Jennifer F. Reinganum

Vanderbilt University - College of Arts and Science - Department of Economics; Vanderbilt University - Law School

Date Written: June 2005

Abstract

We examine the interplay of imperfect competition and incomplete information in the context of price competition among firms producing horizontally- and vertically-differentiated substitute products. We find that incomplete information about vertical quality (e.g., consumer satisfaction), which is signaled via price, softens price competition, and that imperfect competition can reduce the degree to which firms may distort their prices to signal their types (relative to what a monopolist would do). We show that low-quality firms always prefer playing the incomplete information game to the full-information analog: their prices are higher and so are their profits. Moreover, for "high-value" markets, if the proportion of high-quality firms is high enough, high-quality firms also prefer incomplete information to full information. We find conditions such that an increase in the loss to consumers associated with consuming the low-quality product may perversely benefit low-quality firms. We discuss the implications of our analysis for recent tort reform proposals, incentives for the diffusion of general innovation to product-specific improvements, and licensing in markets with uncertain quality.

Keywords: Imperfect competition, quality, signaling, oligopoly

JEL Classification: D43, D82, L15, K13

Suggested Citation

Daughety, Andrew F. and Reinganum, Jennifer F., Imperfect Competition and Quality Signaling (June 2005). Available at SSRN: https://ssrn.com/abstract=759707 or http://dx.doi.org/10.2139/ssrn.759707

Andrew F. Daughety (Contact Author)

Department of Economics, Vanderbilt University ( email )

PMB 351819
2301 Vanderbilt Place
Nashville, TN 37235-1819
United States
615-322-3453 (Phone)
615-343-8495 (Fax)

HOME PAGE: http://my.vanderbilt.edu/andrewdaughety/

Vanderbilt University - Law School

131 21st Avenue South
Nashville, TN 37203-1181
United States

Jennifer F. Reinganum

Vanderbilt University - College of Arts and Science - Department of Economics ( email )

Box 1819 Station B
Nashville, TN 37235
United States
615-322-2937 (Phone)
615-343-8495 (Fax)

Vanderbilt University - Law School

131 21st Avenue South
Nashville, TN 37203-1181
United States

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