Entry deterrence and signaling in markets for search goods

Abstract

This paper studies entry in markets for search goods. Signaling through prices is studied both when an entrant's quality is private information and when it is common knowledge to the entrant and incumbent. When consumers visit a store, they are assumed to observe quality and have the option of continuing to search but at a cost. When search costs are low, an entrant can signal high quality by setting a sufficiently high price, so that consumers who find out that its quality is low visit the incumbent. Entry may be facilitated when search costs are sufficiently low, or when the incumbent knows the quality of the entrant's product.