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Competition and Confidentiality: Signaling Quality in a Duopoly when there is Universal Private Information

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  • Andrew F. Daughety

    () (Department of Economics and Law School, Vanderbilt University)

  • Jennifer F. Reinganum

    () (Department of Economics and Law School, Vanderbilt University)

Abstract

How does the need to signal quality through price affect equilibrium pricing and profits, when a firm faces a similarly-situated rival? In this paper, we provide a model of non-cooperative signaling by two firms that compete over a continuum of consumers. We assume "universal incomplete information;" that is, each market participant has some private information: each consumer has private information about the intensity of her preferences for the firms' respective products and each firm has private information about its own product's quality. We characterize a symmetric separating equilibrium in which each firm's price reveals its respective product quality. We focus mainly on a model in which the quality attribute is safety (so that the legal system is brought into play) and quality is unobservable due to the use of confidential settlements; a particular specification of parameters yields a common model from the industrial organization literature in which quality is interpreted as the probability that a consumer will find the good satisfactory. We show that the equilibrium prices, the difference between those prices, the associated outputs, and profits are all increasing functions of the ex ante probability of high safety. When quality is interpreted as consumer satisfaction, unobservable quality causes all prices to be distorted upward, and lowers average quality and ex ante expected social welfare, but increases ex ante expected firm profits (when either the probability of high quality or the extent of horizontal product differentiation is sufficiently high). When quality is interpreted as product safety, the foregoing results are modified in that for some parameter values ex ante expected social welfare is higher under confidentiality because such legal secrecy lowers expected litigation costs.

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Bibliographic Info

Paper provided by Vanderbilt University Department of Economics in its series Vanderbilt University Department of Economics Working Papers with number 0417.

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Date of creation: Jul 2004
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Handle: RePEc:van:wpaper:0417

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Web page: http://www.vanderbilt.edu/econ/wparchive/index.html

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Keywords: Signaling; quality; safety; confidentiality; duopoly;

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References

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  1. Andrew F. Daughety & Jennifer F. Reinganum, 1994. "Product Safety: Liability, R&D and Signaling," Game Theory and Information 9403007, EconWPA, revised 30 Mar 1994.
  2. Orzach, Ram & Tauman, Yair, 1996. "Signalling Reversal," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 37(2), pages 453-64, May.
  3. Andrew F. Daughety & Jennifer F. Reinganum, 1999. "Hush Money," RAND Journal of Economics, The RAND Corporation, vol. 30(4), pages 661-678, Winter.
  4. Mailath, George J., 1988. "An abstract two-period game with simultaneous signaling--Existence of separating equilibria," Journal of Economic Theory, Elsevier, vol. 46(2), pages 373-394, December.
  5. Claude Fluet & Paolo G. Garella, 1999. "Advertising and Prices as Signals of Quality in a Regime of Price Rivalry," Cahiers de recherche du Département des sciences économiques, UQAM 9903, Université du Québec à Montréal, Département des sciences économiques.
  6. Kyle Bagwell & Garey Ramey, 1989. "Oligopoly Limit Pricing," Discussion Papers 829, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  7. Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061414.
  8. Mailath, George J, 1989. "Simultaneous Signaling in an Oligopoly Model," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 417-27, May.
  9. Cho, In-Koo & Kreps, David M, 1987. "Signaling Games and Stable Equilibria," The Quarterly Journal of Economics, MIT Press, vol. 102(2), pages 179-221, May.
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  13. Yang, Bill Z., 1996. "Litigation, experimentation, and reputation," International Review of Law and Economics, Elsevier, vol. 16(4), pages 491-502, December.
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  17. Mark N. Herzendorf & Per Baltzer Overgaard, 2001. "Prices as Signals of Quality in Duopoly," CIE Discussion Papers 2001-01, University of Copenhagen. Department of Economics. Centre for Industrial Economics.
  18. Jennifer F. Reinganum & Andrew F. Daughety, 2004. "Secrecy and Safety," Econometric Society 2004 North American Summer Meetings 53, Econometric Society.
  19. Mas-Colell, Andreu & Whinston, Michael D. & Green, Jerry R., 1995. "Microeconomic Theory," OUP Catalogue, Oxford University Press, number 9780195102680, July.
  20. Andrew F. Daughety & Jennifer F. Reinganum, 2002. "Informational Externalities in Settlement Bargaining: Confidentiality and Correlated Culpability," RAND Journal of Economics, The RAND Corporation, vol. 33(4), pages 587-604, Winter.
  21. Matthews, Steven A & Mirman, Leonard J, 1983. "Equilibrium Limit Pricing: The Effects of Private Information and Stochastic Demand," Econometrica, Econometric Society, vol. 51(4), pages 981-96, July.
  22. Nancy A. Lutz, 1989. "Warranties as Signals under Consumer Moral Hazard," RAND Journal of Economics, The RAND Corporation, vol. 20(2), pages 239-255, Summer.
  23. Mark N. Hertzendorf, 1993. "I'm Not a High-Quality Firm -- But I Play One on TV," RAND Journal of Economics, The RAND Corporation, vol. 24(2), pages 236-247, Summer.
  24. Klein, Benjamin & Leffler, Keith B, 1981. "The Role of Market Forces in Assuring Contractual Performance," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 615-41, August.
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Citations

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Cited by:
  1. LG. Deidda & F. Adriani, 2010. "Competition and the signaling role of prices," Working Paper CRENoS 201012, Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia.
  2. Andrew F. Daughety & Jennifer F. Reinganum, 2006. "Products Liability, Signaling and Disclosure," Vanderbilt University Department of Economics Working Papers 0625, Vanderbilt University Department of Economics.
  3. Andrew F. Daughety & Jennifer F. Reinganum, 2007. "Communicating Quality: A Unified Model of Disclosure and Signaling," Vanderbilt University Department of Economics Working Papers 0703, Vanderbilt University Department of Economics.
  4. Winand Emons & Claude Fluet, 2011. "Non-Comparative versus Comparative Advertising of Quality," Cahiers de recherche 1139, CIRPEE.
  5. Leonard J. Mirman & Marc Santugini, 2011. "The Simple Analytics of Price Signaling Quality," Cahiers de recherche 11-04, HEC Montréal, Institut d'économie appliquée.
  6. P. Vanin, 2009. "Competition, Reputation and Cheating," Working Papers 683, Dipartimento Scienze Economiche, Universita' di Bologna.
  7. Leonard J. Mirman & Marc Santugini, 2011. "Noisy Signaling in Monopoly," Cahiers de recherche 11-03, HEC Montréal, Institut d'économie appliquée.
  8. Alexander E. Saak, 2011. "A Model of Labeling with Horizontal Differentiation and Cost Variability," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 93(4), pages 1131-1150.
  9. Laurent Linnemer, 2008. "Dissipative Advertising Signals Quality even without Repeat Purchases," CESifo Working Paper Series 2310, CESifo Group Munich.
  10. Zhu, Xiaowei & Mukhopadhyay, Samar K. & Yue, Xiaohang, 2011. "Role of forecast effort on supply chain profitability under various information sharing scenarios," International Journal of Production Economics, Elsevier, vol. 129(2), pages 284-291, February.
  11. Andrei Dubovik & Maarten C.W. Janssen, 2008. "Oligopolistic Competition in Price and Quality," Tinbergen Institute Discussion Papers 08-068/1, Tinbergen Institute.
  12. P. Vanin, 2009. "Competition, Reputation and Compliance," Working Papers 682, Dipartimento Scienze Economiche, Universita' di Bologna.
  13. Andrew F. Daughety & Jennifer F. Reinganum, 2006. "Hidden Talents: Partnerships with Pareto-Improving Private Information," Vanderbilt University Department of Economics Working Papers 0613, Vanderbilt University Department of Economics.

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