Working Paper: CEPR ID: DP713
Authors: ramon caminal; xavier vives
Abstract: We analyse the informational content of market shares and prices in a dynamic duopoly model in which consumers have heterogenous information on the quality differential (q) of two goods. It is shown that when firms are poorly informed about q, and therefore the ability of prices to reveal information is limited, consumers rationally believe that a firm with a high market share is likely to produce a high-quality good. As a result, firms try to signal-jam the inferences of consumers and compete for market shares beyond the level explained by short-run profit maximization. The consequence is that the market is more competitive in the first stages of the game and approaches the benchmark one-shot full information equilibrium prices as consumers and firms learn about q. Further, it is found that consumers display herd behaviour with the consequence that they learn q slowly, slowing down, in turn, the rate of convergence of prices to their benchmark levels. When firms are informed about q, and prices have the potential to signal quality, multiple equilibria may exist, but there is always one equilibrium in which market shares are a positive signal of quality.
Keywords: oligopoly; market share; consumer learning; herd behaviour; signal-jamming; quality signals
JEL Codes: 026; 611
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high market shares (L17) | consumer beliefs about quality (L15) |
| consumer beliefs about quality (L15) | demand for high market share firm's product (L21) |
| market shares (L17) | pricing strategies (D49) |
| pricing strategies (D49) | future consumer demand (R22) |
| consumer beliefs about quality (L15) | pricing strategies (D49) |
| herd behavior (C92) | rate of learning about true quality differential (L15) |
| market shares (L17) | price convergence (D41) |
| quality differential (q) (L15) | consumer beliefs about quality (L15) |