Price Competition and Advertising Signals: Signaling by Competing Senders

Abstract

Can price and advertising be used by vertically differentiated duopolists to signal qualities to consumers?We show that pure price separation is impossible if the vertical differentiation is small, while adding dissipative advertising ensures existence of separating equilibria.Two simple, but non-standard, equilibrium refinements are introduced to deal with the multi-sender nature of the game, and they are shown to produce a unique separating and a unique pooling profile.Pooling results in a zero-profit Bertrand outcome.Separation gives strictly positive duopoly profits, and dissipative advertising is used by the high-quality firm when products are sufficiently close substitutes.Finally, depending on the differentiation, the separating prices of both firms may be distorted upwa.rds or downwards compared to the complete information benchmark.I This paper reflects the views of the authors and does not necessarily reflect the views of the Federal Trade Commission or any individual Commissioner.S In a monopoly signaling game sales might also be lost as the result of price signaling, but not to a competitor.6 These assumptions are similar to assumptions made by Gabszewicz and Grilo (1992), who study a similar problem in a nonsignaling context.