Signaling Quality Through Prices in an Oligopoly

Firms signal high quality through high prices even if the market structure is very competitive and price competition is severe. In a symmetric Bertrand oligopoly where products may differ only in their quality and each firm’s product quality is private information (unknown to consumers and to other firms), we show that there exist fully revealing perfect Bayesian equilibria where low quality firms choose random pricing strategies, exercise market power and high quality firms charge higher prices than low quality firms. The market power and profits of low quality firms depend on the market power exercised by high quality firms and the latter varies considerably across revealing equilibria. There is a unique symmetric fully revealing equilibrium satisfying the D1 refinement criterion; in this equilibrium too, both low and high quality firms may exhibit considerable market power. While the market power exercised by low quality firms vanishes as the number of firms becomes large, that for high quality firms may persist. Finally, every D1 equilibrium outcome involves some revelation of information.