IDEAS home Printed from https://ideas.repec.org/a/zbw/ifweej/20175.html
   My bibliography  Save this article

Reexamining the Schmalensee effect

Author

Listed:
  • Kim, Jeong-Yoo
  • Berg, Nathan

Abstract

The authors reexamine the Schmalensee effect from a dynamic perspective. Schmalsensee's argument suggesting that high quality can be signaled by high prices is based on the assumption that higher quality necessarily incurs higher production cost. In this paper, the authors argue that firms producing high-quality products have a stronger incentive to lower the marginal cost of production cost because they can then sell larger quantities than low-quality firms can. If this dynamic effect is large enough, then the Schmalensee effect degenerates and, thus, low prices signal high quality. This result is different from the Nelson effect relying on the assumption that only the high-quality product can generate repeat purchase, because the result is valid even if low-quality products can also be purchased repeatedly. The authors characterize a separating equilibrium in which a high-quality monopolist invests more to reduce cost and, as a result, charges a lower price. Separation is possible due to a difference in quantities sold in the second period across qualities.

Suggested Citation

  • Kim, Jeong-Yoo & Berg, Nathan, 2017. "Reexamining the Schmalensee effect," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 11, pages 1-12.
  • Handle: RePEc:zbw:ifweej:20175
    as

    Download full text from publisher

    File URL: http://dx.doi.org/10.5018/economics-ejournal.ja.2017-5
    Download Restriction: no

    File URL: https://www.econstor.eu/bitstream/10419/156480/1/883821699.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Daughety, Andrew F & Reinganum, Jennifer F, 1995. "Product Safety: Liability, R&D, and Signaling," American Economic Review, American Economic Association, vol. 85(5), pages 1187-1206, December.
    2. Schmalensee, Richard, 1978. "A Model of Advertising and Product Quality," Journal of Political Economy, University of Chicago Press, vol. 86(3), pages 485-503, June.
    3. Chenavaz Régis, 2017. "Better Product Quality May Lead to Lower Product Price," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 17(1), pages 1-22, January.
    4. 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.
    5. Kenneth L. Judd & Michael H. Riordan, 1994. "Price and Quality in a New Product Monopoly," Review of Economic Studies, Oxford University Press, vol. 61(4), pages 773-789.
    6. Nelson, Phillip, 1970. "Information and Consumer Behavior," Journal of Political Economy, University of Chicago Press, vol. 78(2), pages 311-329, March-Apr.
    7. Ayca Kaya, 2013. "Dynamics of price and advertising as quality signals: anything goes," Economics Bulletin, AccessEcon, vol. 33(2), pages 1556-1564.
    8. Bagwell, Kyle & Riordan, Michael H, 1991. "High and Declining Prices Signal Product Quality," American Economic Review, American Economic Association, vol. 81(1), pages 224-239, March.
    9. Nelson, Philip, 1974. "Advertising as Information," Journal of Political Economy, University of Chicago Press, vol. 82(4), pages 729-754, July/Aug..
    10. Asher Wolinsky, 1983. "Prices as Signals of Product Quality," Review of Economic Studies, Oxford University Press, vol. 50(4), pages 647-658.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    experience good; quality; signal; Schmalensee effect;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:zbw:ifweej:20175. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (ZBW - German National Library of Economics). General contact details of provider: http://edirc.repec.org/data/iwkiede.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.