Abstract
Abstract If a product has two dimensions of quality, one observable and one not, a firm can use observable quality as a signal of unobservable quality. The correlation between consumers’ valuation of high quality in each dimension is a key determinant of the feasibility of such signaling. A firm may use price alone as a signal, or price and quality together. Both signals tend to be used when the market is very uninformed, whereas price signaling alone tends to be used when the market is moderately informed. If high observable quality is inexpensive to provide, then it cannot signal high unobservable quality, and low observable quality is always an indication that unobservable quality is high.
Highlights
It may seem that consumers who demand high quality will demand it in all dimensions
Relatively low-quality wines are packaged in this manner; only the low-quality content is available in the high-quality packaging, and high-quality content is only available in the low-quality packaging
For products that have an observable dimension of quality and an unobservable dimension of quality, a rm may lower the observable quality as a means of signaling unobservable quality
Summary
It may seem that consumers who demand high quality will demand it in all dimensions. The consumer might choose the product that is of low quality in the only observable characteristic This is a rational choice for the consumer if the packaging is a signal of the quality of the content. This would mean that consumers who value high-quality content very highly are close to indifferent between the two kinds of packaging. Because this opportunity cost is higher for a low-quality rm, the high-quality rm does not have to distort price greatly to signal effectively.
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