Economic Theory and Experimental Seminar - Sander Heinsalu (Australian National University)

Title: Competitive pricing despite search costs when lower price signals quality

Abstract: This article shows that firms price competitively and consumers can infer product quality from prices, even if learning prices is costly. Firms differ in quality and production cost, which are negatively correlated across firms, due to e.g. regulation, differing managerial talent, or economies of scale. If good-quality firms have lower costs, then they can signal quality by cutting prices, in which case bad-quality firms must cut prices to retain customers. This price-cutting race to the bottom ends in a separating equilibrium in which the bad-quality firms charge their competitive price and the good-quality firms charge slightly less.