Will the high-quality producer please stand up?: A model of duopoly signaling
We analyze how duopoly competition affects the incentives of firms to signal quality through prices. One firm has a high quality, the other a low, but initially potential customers are unable to verify who has the high quality. The incentives are such that the high quality firm prefers to reveal its identify, whereas the low quality firm prefers to hide. The scope for separation of the qualities is shown to be related to the size of the quality difference. If the difference is small, separation is mpossible, but if the difference is sufficiently large, the high quality firm can separate in equilbirum. We conclude that, whether there is pooling or separation, in a focal equilibrium the prices of both firms are likely distorted above their full information levels. Non-standard equilibrium refinements are proposed to deal with the added complexities of competitive duopoly signaling.
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