Do high prices signal high quality? A theoretical model and empirical results

Abstract

This paper has three objectives. First, we develop an equilibrium pricing model in which consumers have incomplete information about both product qualities and prices. Specifically, manufacturers can use high prices to signal high quality to uninformed consumers. Furthermore, prices of any given brand can vary geographically across retail outlets. We show that previous models are special cases of our model. Specifically, the hedonic regression model assumes that consumers have full information about all product qualities and prices. Second, we propose a methodology for testing price‐signaling models. Third, we test our model using data from consumer reports for several consumer durable and nondurable products. The results show that firms use prices to signal quality, regardless of whether they market durable or nondurable products. The results do not support the popular theory that markets for experience goods are more efficient than those for search goods. Finally, our model outperforms the standard hedonic regression model for four of the five product categories analyzed.

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