Competition and the Signaling Role of Prices

In a market where sellers are heterogeneous with respect of the quality of
their good and are more informed than buyers, high quality sellers’ chances to
trade might depend on their ability to inform buyers about the quality of the
goods they offer. We study how the strength of competition among sellers affects
the ability of sellers of high quality goods to achieve communication by means
of appropriate pricing decisions in the context of a market populated by a large
number of strategic price setting sellers and a large number of buyers. When
competition among sellers is weak high quality sellers are able to use prices as
a signaling device and this enables them to trade. By contrast, strong competition among sellers inhibits the role of prices as signals of high quality, and high
quality sellers are driven out of the market.