ESSAYS ON INFORMATION TRANSFER AND MARKET PERFORMANCE

When market participants are asymmetrically informed, the fact that uninformed agents draw inferences from the observed actions of informed agents gives rise to distortions of the incentives present under complete information. The prevalence of asymmetric information in actual markets makes it important to carefully explore the nature of these distortions.

The first essay presents a general model of large-scale entry in which two firms choose capacity sequentially under demand uncertainty, but the initial entrant's first-period price can signal demand information to the second entrant. In an informative equilibrium, the incumbent employs the limit-pricing strategy described by Bain (American Economic Review, 1949) as a means of communicating that the industry is a natural monopoly. For existence of such informative equilibria, it is necessary and sufficient that the entrant's response time to signals be slow. Equilibria become arbitrarily uninformative for sufficiently quick response time. Finally, even when all demand information is signaled, entry will not be the same as under complete information.

The second essay examines monopoly pricing, advertising and warranty provision when the firm and consumers are asymmetrically informed as to the quality of the product. When greater actual quality has the effect of raising production costs and quality is signaled through price, the firm will choose prices above complete-information monopoly levels. Signaling through price and advertising increases consumer welfare and reduces profits relative to signaling through price alone. When quality is signaled through price and warranty, consumer welfare improves when warranties are a sufficiently close substitute for quality, and profits improve if the effect of actual quality on warranty costs outweighs its effect on production costs.

The final essay studies repeat business mechanisms in markets where quality varies over time and cannot be observed prior to purchase. In a one period model, higher quality products will earn lower profits even when price transfers all information about quality. If price is fully-informative in every period of a dynamic model, then repeat business threats have no credibility, while threats are credible when price is uninformative. Thus, the market cannot both transfer information and provide an incentive to invest in quality.