Abstract
This paper considers price competition in a duopoly with quality uncertainty. The established firm (the ‘incumbent’) offers a quality that is publicly known; the other firm (the ‘entrant’) offers a new good whose quality is not known by some consumers. The incumbent is fully informed about the entrant’s quality. This leads to price signalling rivalry because the incumbent gains and the entrant loses if observed prices make the uninformed consumers more pessimistic about the entrant’s quality. When the uninformed consumers’ beliefs satisfy the ‘intuitive criterion’ and the ‘unprejudiced belief refinement’, prices signal the entrant’s quality only in a two–sided separating equilibrium and are identical to the full information outcome.
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Notes
1Linnemer L (2002) shows that in the same setup it would be in some cases more profitable for the high-type firm to combine price and advertising signals.
2 This is equivalent to setting γ≡1.
3 We restrict ourselves to pure strategy equilibria.
5 In our analysis the term ‘unprejudiced belief criterion’ always refers to the simplified version defined above.
6Yehezkel (2006) proposes a generalization of the unprejudiced belief criterion that eliminates all possible separating equilibria but the full information outcome.
7Recall that t>(Δ−c)/3
8 The analysis of (partial) pooling equilibria is likely to be complicated by several necessary case distinctions. First, there are four possible equilibrium constellations since each of the two firms can adopt either full or partial pooling. Second, for the equilibrium prices and all deviations from equilibrium one has to consider not only prices that leave both firms with a positive market share but also prices that would drive one of the firms out of the market.
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We wish to thank three referees for helpful comments and suggestions. Support by the German Science Foundation (DFG) through SFB/TR 15 is gratefully acknowledged.
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Bester, H., Demuth, J. Signalling Rivalry and Quality Uncertainty in a Duopoly. J Ind Compet Trade 15, 135–154 (2015). https://doi.org/10.1007/s10842-014-0178-0
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DOI: https://doi.org/10.1007/s10842-014-0178-0