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Imperfect Competition and Quality Signaling

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Author Info
Andrew F. Daughety () (Department of Economics and Law School, Vanderbilt University)
Jennifer F. Reinganum () (Department of Economics and Law School, Vanderbilt University)

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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) that is signaled via price softens price competition, and that imperfect competition can reduce the degree to which firms 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 great 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 professional licensing.

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File URL: http://www.vanderbilt.edu/Econ/wparchive/workpaper/vu05-w20.pdf
File Format: application/pdf
File Function: Revised version, 2005
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Publisher Info
Paper provided by Department of Economics, Vanderbilt University in its series Working Papers with number 0520.

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Date of creation: Jul 2005
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Handle: RePEc:van:wpaper:0520

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Related research
Keywords: Imperfect competition quality signaling oligopoly

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Find related papers by JEL classification:
D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
K13 - Law and Economics - - Basic Areas of Law - - - Tort Law and Product Liability
L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  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. [Downloadable!]
    Other versions:
  2. 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. [Downloadable!] (restricted)
  3. Esther Gal-Or, 1988. "The Advantages of Imprecise Information," RAND Journal of Economics, The RAND Corporation, vol. 19(2), pages 266-275, Summer. [Downloadable!] (restricted)
  4. 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. [Downloadable!] (restricted)
    Other versions:
  5. Mark N. Hertzendorf & Per Baltzer Overgaard, 2001. "Price Competition and Advertising Signals: Signaling by Competing Senders," Journal of Economics & Management Strategy, Blackwell Publishing, vol. 10(4), pages 621-662, December. [Downloadable!] (restricted)
  6. 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. [Downloadable!] (restricted)
  7. Joseph E. Harrington Jr., 1987. "Oligopolistic Entry Deterrence under Incomplete Information," RAND Journal of Economics, The RAND Corporation, vol. 18(2), pages 211-231, Summer. [Downloadable!] (restricted)
  8. 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. [Downloadable!] (restricted)
  9. Andrew Daughety & Jennifer Reinganum, . "Secrecy and Safety," American Law & Economics Association Annual Meetings 1039, American Law & Economics Association. [Downloadable!]
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  10. Mailath, George J, 1989. "Simultaneous Signaling in an Oligopoly Model," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 417-27, May. [Downloadable!] (restricted)
  11. Milgrom, Paul & Roberts, John, 1986. "Price and Advertising Signals of Product Quality," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 796-821, August. [Downloadable!] (restricted)
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  12. Helmut Bester, 1998. "Quality Uncertainty Mitigates Product Differentiation," RAND Journal of Economics, The RAND Corporation, vol. 29(4), pages 828-844, Winter. [Downloadable!] (restricted)
  13. 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. [Downloadable!]
  14. Fluet, Claude & Garella, Paolo G., 2002. "Advertising and prices as signals of quality in a regime of price rivalry," International Journal of Industrial Organization, Elsevier, vol. 20(7), pages 907-930, September. [Downloadable!] (restricted)
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  15. Kyle Bagwell & Garey Ramey, 1991. "Oligopoly Limit Pricing," RAND Journal of Economics, The RAND Corporation, vol. 22(2), pages 155-172, Summer. [Downloadable!] (restricted)
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  16. Bagwell, Kyle, 1992. "Pricing to Signal Product Line Quality," Journal of Economics & Management Strategy, Blackwell Publishing, vol. 1(1), pages 151-74, Spring.
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  17. Martin, Stephen, 1995. "Oligopoly limit pricing: Strategic substitutes, strategic complements," International Journal of Industrial Organization, Elsevier, vol. 13(1), pages 41-65, March. [Downloadable!] (restricted)
  18. Linnemer, L., 1996. "Entry Deterrence, Product Quality: Price and Advertising as Signals," Papers 9628, Institut National de la Statistique et des Etudes Economiques-.
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  19. Das Varma, Gopal, 2003. "Bidding for a process innovation under alternative modes of competition," International Journal of Industrial Organization, Elsevier, vol. 21(1), pages 15-37, January. [Downloadable!] (restricted)
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Andrew F. Daughety & Jennifer F. Reinganum, 2007. "Mass Torts and the Incentives for Suit, Settlement, and Trial," Working Papers 0713, Department of Economics, Vanderbilt University. [Downloadable!]
  2. Maarten C.W. Janssen & Santanu Roy, 2007. "Signaling Quality Through Prices in an Oligopoly," Departmental Working Papers 0709, Southern Methodist University, Department of Economics. [Downloadable!]
    Other versions:
  3. Kamphorst, Jurjen J.A. & Van Velthoven, Ben C.J., 2006. "The introduction of an appeals court in Dutch tax litigation," MPRA Paper 2008, University Library of Munich, Germany, revised 27 Apr 2006. [Downloadable!]
  4. Guiseppe Dari-Mattiacci & Bruno Deffains, 2006. "Uncertainty of Law and the Legal Process," Tinbergen Institute Discussion Papers 06-071/1, Tinbergen Institute. [Downloadable!]
  5. Che, Yeon-Koo & Spier, Kathryn, 2007. "Exploiting Plaintiffs Through Settlement: Divide and Conquer," MPRA Paper 6104, University Library of Munich, Germany. [Downloadable!]
  6. Yeon-Koo Che & Kathryn E. Spier, 2007. "Exploiting Plaintiffs Through Settlement: Divide and Conquer," Discussion Papers 0607-18, Columbia University, Department of Economics. [Downloadable!]
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