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Signaling Unobservable Quality Choice through Price and Advertising: The Case with Competing Firms
Author(s) -
Wu Fulan
Publication year - 2017
Publication title -
the manchester school
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.361
H-Index - 42
eISSN - 1467-9957
pISSN - 1463-6786
DOI - 10.1111/manc.12145
Subject(s) - unobservable , monopoly , economics , competition (biology) , microeconomics , quality (philosophy) , outcome (game theory) , signaling game , informative advertising , oligopoly , duopoly , benchmark (surveying) , welfare , econometrics , cournot competition , market economy , computer science , online advertising , ecology , philosophy , the internet , geodesy , epistemology , advertising account executive , world wide web , biology , geography
This paper develops a model in which a firm can use price and advertising jointly as a signal of their private choice of quality, whereby quality is endogenously chosen by firms. The monopoly model reveals that there exists a unique equilibrium in which the monopolist chooses high quality but a higher level of advertising compared to the full‐information benchmark. The model is then extended to the case with competition of two imperfectly competitive firms. We find that if competition is not strong enough, then there exists a unique symmetric equilibrium in which both firms choose high quality. The equilibrium outcome shows that both firms will set lower prices and a higher level of advertising as compared to the monopoly case. Interestingly, we find that more competition might lead to a loss of social welfare due to the increasing level of advertising for quality signaling. The numerical results further demonstrate that as competition gets more intense from the monopoly, prices decrease initially, the level of advertising increases, and social welfare decreases, which may make a ban on advertising more recommendable after a certain threshold.