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Prices as signals of product quality in a duopoly
1 : Southwestern University of Finance and Economics, Research Institute of Economics and Management
Chengdu, Sichuan -
China
2 : Drexel University, School of Economics, Bennett S. LeBow College of Business
Philadelphia PA 19104 -
United States
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.
