Incomplete Information, Signaling, and Competition

Abstract

This chapter analyzes strategic interaction of firms under incomplete information. Exercise 9.1 studies entry decisions when the incumbent’s cost is unobservable to the entrant. We show that the low-cost firm can strategically increase output relative to the complete information setting, to the level that the high-cost firm cannot profitably imitate, in order to deter entry. Exercise 9.2 examines the firm’s incentives to offer damaged goods at an extra cost. We find that consumers are better off since high-value consumers can buy the undamaged version of the good at a lower price while low-value consumers can buy the damaged good who are otherwise not served. Exercise 9.3 considers firms’ incentives to invest in corporate social responsibility (CSR) when consumers do not receive accurate signal on product quality. We report that the high-quality firm can invest in CSR to signal its product differentiation from low-quality rivals, and CSR investments are usually observed in market with noisy signals such as fashionable clothes, cosmetics, and electronics to distinguish from counterfeit or inferior products. Exercise 9.4 identifies firms’ intertemporal pricing decisions when they can advertise and poach consumers from one another. We find that in a symmetric setting, every firm obtains an equal share of the market in the first period, and sells to its rival’s consumers at a price half of that selling to its own consumers in the second period.