Vertical Differentiation With Consumers Misperceptions And Information Disparities

We consider vertical differentiation with quality uncertainty and information disparities, in a duopoly where firms supply a product with credence attributes. Consumers choice is affected by misperceptions, but equilibrium prices and qualities depend also on the behavior and the share of informed consumers. With optimistic misperceptions uninformed consumers are cheated in equilibrium as we observe less price competition and minimum differentiation. Alternatively some product differentiation is provided when informed consumers buy high quality goods and the incentive to increase quality is positively affected by optimistic misperceptions. With more informed consumers we find more price competition but less incentive to product differentiation. In most cases the share of informed consumers asymmetrically affects equilibrium prices, to the detriment of the high quality firm. Pessimistic misperceptions prevent more product differentiation and adverse selection arises, but it can be eliminated if the share of informed consumers is high enough. However with pessimistic consumers, information disparities can also lead to inelastic demands and market segmentation, such that externalities