We reexamine the role of prices and advertising expenditures as signals of quality. Consumers are either "fastidious" or "indifferent." Fastidious individuals value high quality more and low quality less than do indifferent individuals. Then a sensible and robust separating equilibrium exists in which both types set their full-information prices. However, the high-quality firm cuts advertising below the full-information level of the low-quality firm, even if the full-information advertising expenditures of the high-quality firm are larger than those of the low-quality firm. Consumers respond favorably to advertising cuts and correctly identify quality. Hence, modest advertising may signal high quality.
|Number of pages||19|
|Journal||RAND Journal of Economics|
|State||Published - 2002|