Information Acquisition, signaling and learning in duopoly

Abstract

We study firms’ incentives to acquire private information on cost in a duopoly signaling game. Firms first choose how much to invest in information acquisition and then engage in dynamic price competition. In equilibrium firms acquire too little information from the perspective of industry profit and the perspective of social welfare. We consider two policies that an industry trade association may institute in light of this: (i) the trade association invests directly to acquire private information for each firm, and (ii) firms individually invest in acquiring private information on their costs, and the trade association collects this information and disseminates it after first period prices have been set. Allowing the trade association to acquire information increases firms’ profits and may also increase consumer surplus. Information sharing eliminates firms’ signaling incentives, and as a result leads to more information acquisition by the firms and higher consumer surplus as well as higher social welfare. However, information sharing increases firms’ profits only when the ex ante uncertainty about cost is large, and it reduces profits otherwise.