Deceptive Advertising with Rational Buyers
We study a Bertrand game where two sellers supplying products of different and unverifiable qualities can outwit potential clients through (costly) deceptive advertising. We characterize a class of pooling equilibria where sellers post the same price regardless of their quality and low quality ones deceive buyers. Although in these equilibria low quality goods are purchased with positive probability, the buyer’s (expected) utility can surprisingly be higher than in a fully separating equilibrium, which suggests that (absent price regulation) a per se rule banning deceptive practices may harm consumers. We also argue that sellers invest more in deceptive advertising the better their reputation vis-à-vis potential clients – i.e., firms that are better trusted by customers, have greater incentives to invest in deceptive advertising. Finally, we characterize the optimal monitoring effort exerted by a regulatory agency who seeks to identify and punish deceptive practices. We show that consumer surplus maximization requires a higher monitoring e¤ort than social welfare maximization.
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