IO Seminar (Daughety and Reinganum)

Original article (link) posted: 21/09/2005

Daughety and Reinganum "Imperfect Competition and Quality Signaling"

The paper investigates the one-shot oligopoly model where firms produce substitute products with associated vertical quality measure. Each firm has private information about its quality (="type") and signaling effects by pricing are captured. Their main focus is comparison between separating equilibria of incomplete information (about vertical quality) and that of complete information.
As main results, they show the following;

1) incomplete information (signaled via prices) softens price competition, and imperfect competition can reduce the degree to which firms distort their prices to signal their types
2) low-quality firms always prefer playing the incomplete information game to the full-information analog
3) if the proportion of high-quality firms is great enough, they also prefer incomplete information to full-information

It is very difficult for me to judge their contribution in this field because there are so many papers in the literature and some of them look quite similar to this paper at least for those who are not familiar with this line of research. The model in the paper tries to capture the both effects of incomplete information and imperfect competition, which makes it very complicated. Although the main results mentioned above sound interesting, similar kind of qualitative results can be derived in simpler model I guess. For example, the comparison between a separating equilibrium and a pooling one in a simple Spence type signaling model has the implications quite similar to (2) and (3). Of curse, except for the results (1)-(3), they show a bunch of comparative static and some of them are interesting and not obvious. However, I would like to say it should be needed for them to say why such a complicated model is used to explain the results most of which were already known and hence not surprising.
The literature review (Section 2) is comprehensive. So, if you are interested in the paper, it might be better to read some key references before deeply tackle this paper.

Interesting papers in References

Bagwell and Riordan (1991) "High and Declining Prices Signal Product Quality" AER, 81
Mailath (1989) "Simultaneous Signaling in an Oligopoly Model" QJE, 104
Martin (1995) "Oligopoly Limit Pricing: Strategic Substitutes, Strategic Complements" IJIO, 13

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