Advertising and Price Signaling of Quality in a Duopoly with Endogenous Locations

We analyze a two-sender quality-signaling game in a duopoly model where goods are horizontally and vertically dierentiated. While locations are chosen under quality uncertainty, firms choose prices and advertising expenditures being privately informed about their types. We show that pure price separation is impossible, and that dissipative advertising is necessary to ensure existence of separating equilibria. Equilibrium refinements discard all pooling equilibria and select a unique separating equilibrium. When vertical differentiation is not too high, horizontal differentiation is maximum, the high-quality firm advertises, and both firms adopt prices that are distorted upwards (compared to the symmetric-information benchmark). When vertical differentiation is high, firms choose identical locations and ex post, only the high-quality firm obtains positive profits. Incomplete information and the subsequent signaling activity are shown to increase the set of parameters values for which maximum horizontal differentiation occurs.