Price signaling and the strategic benefits of price rigidities

Adriani, Fabrizio; Deidda, Luca

Abstract

We analyze trade between a perfectly informed price setting party (seller) and an imperfectly informed price taker (buyer). Differently from most of the literature, we focus on the case in which, under full information, it would be inefficient to trade goods of sufficiently poor quality. We show that the unique equilibrium surviving D1 is characterized by market breakdown, although trade would be mutually beneficial in some state of nature. This occurs independently of the precision of the information available to the buyer. The model thus implies that signaling through prices may exacerbate the effect of adverse selection rather than mitigate it. Under D1, the seller would always benefit from committing to prices that do not reveal her information. We develop this intuition by analyzing the strategic advantages of price rigidities. We show that price rigidities help restore trade and could even enhance effectiveness of prices as signals of quality.

Citation

Adriani, F., & Deidda, L. (2009). Price signaling and the strategic benefits of price rigidities. Games and Economic Behavior, 67(2), 335-350. https://doi.org/10.1016/j.geb.2009.03.005

• Journal Article Type: Article
• Publication Date: Nov 1, 2009
• Deposit Date: Oct 1, 2009
• Journal: Games and Economic Behavior
• Print ISSN: 0899-8256
• Electronic ISSN: 1090-2473
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 67
• Issue: 2
• Pages: 335-350
• DOI: https://doi.org/10.1016/j.geb.2009.03.005
• Keywords: Market for lemons; Signaling; Two-sided asymmetric information; Professional bodies; Market breakdown; Price rigidities
• Publisher URL: http://www.elsevier.com/wps/find/journaldescription.cws_home/622836/description#description