Lecture on microeconomics under supervision of Prof. Karl Storchmann of the Whitman College, NY, USA

1. presentation

2. Back in the day,
an apple was an apple.
Source: Scitovszky (1944-45)

3. Today, it‘s a bit more complicated...
Source: Scitovszky (1944-45)

4. As a consumer you have a great
information disadvantage.
Source: Akerlof (1970)

5. How can you find out the true
quality of a product?
Source: Akerlof (1970)

6. Source: Cooper (1984)

7. Source: Cooper (1984)

8. Source: Cooper (1984)

9. SIGNALING QUALITY WITH PRICES
ALEXANDER KRAEMER | BOCHUM | AUGUST 2010
Student of Management and Economics (Diplom), ID.no. 108 004 216 923
alexander.kraemer@rub.de

10. Agenda
 Theoretical Literature
 Firms I Consumers
 Empirical Literature
 Overview I Aspects
 Resumé
 References

11. Theoretical
Literature

12. Why signal?
the informed the uninformed
Source: Koku (1995)

13. Why signal?
information gap
the informed the uninformed
Source: Koku (1995)

14. Why signal?
Building a bridge over
the information gap
Source: Koku (1995)

15. An example: Job application
Source: Spence (1973)

16.  Indices
 Gender, age or race
 Ex ante observable information
 Signals
 Work experience, education or motivation
 Ex post obeserable information
 Can be manipulated by applicant
 Manipulation of signals might incur costs
Source: Spence (1973)

17. Pricing strategies
Price
Penetration Strategy
Skimming Strategy
Costs
Time
Source: Robinson (1975), Koku (1995)

18. Mixed qualities
 Non-constant costs can play important role
 Average costs can rise when sales fall
 Reduction of false signaling firms
 Increase of information on quality
 Leaving some false firms, but also good
Source: Cooper (1984)

19. High and declining prices
High quality firm
 Low costs
 Fakes quality
 High costs
 Will lose great sales volume
 Willing to restrict sales volume
 Over time high costs to signal
 Will lose less sales volume
false quality
 Over time less costly to signal
quality
Low quality firm
Source: Bagwell & Riordan (1991)

20. Freeriding low-quality firms
 High information asymmetry
 Nothing prevents signaling with high prices
 Price does not reveal the true quality of a product
Source: Alpert et al. (1993)

21. The use of price as a
signal depends on...
 Consumers‘ ability to detect quality variation
 Level of price awareness of consumers
 Availability of other cues of quality
 Actual quality variation
 Price variation
Source: Zeithaml (1988)

22. When is price relevant?
 Consumers rely on more than one signal
 There is an optimum number of signals
 The more expensive the product
the more signals the consumer uses
Source: Jones & Hudson (1996)

23. Relationship between price, quality and value
Source: Zeithaml (1988)

24. Prices signal true quality
in every equilibrium
 Consumers have certain quality expectancies
 Consumers penalize firms who signal the wrong
quality
 Existence of expectancy equilibria
 Prices may serve as signals which differentiate
quality levels
 Consumers have qualities they will spend money on
Source: Wolinsky (1983); Gabor & Granger (1966)

25. Empirical
Literature

26. Price-Quality Correlations
 Most products price and objective quality are positively correlated
 Most correlations are weak and vary over time
 Strength of correlation depends on two factors
 Type of product (durable vs. nondurable)
 Degree of price despersion in a product category
 Price is a poor market signal of quality for most products
Source: Steenkamp (1988)

27. Price-Quality Relations
Source: Faulds & Lonial (2001)

28. Price-Quality Relations
Source: Faulds & Lonial (2001)

29. Cultural differences
 Prices have an allocative effect in china
 No quality is transported
 Low prices have same effect as high prices
Source: Erevelles et al. (2001)

30. What Price Quality?
 What cues do consumers use to select wine?
 Quality ratings by James Halliday as dependant variable
 Analysis of Australian and New Zealand wines
 Influence of cues is different for each of the wines
 e.g. Regional influence on wine quality and the winery style
 Some producers might be better than others
 Positive relationship between price and quality
 Relationship is not linear
 Increase in price does not explain equal incraese in quality
Source: Horowitz & Lockshin (2002)

31. What Price Quality?
 Consumers go into a store with a style and a price range and then
look for wines within those parameters
All prices in Australian Dollars Source: Horowitz & Lockshin (2002)
(1 AUSD = 0.72 EUR as of 19.08.2010)

32. How do consumers use signals to
assess quality?
 Analysis 6,000 European wine consumers
 Speciality of paper: connoisseurs & nonconnoisseurs
 Do all consumers use signals in the same way?
Source: Gergaud & Livat (2007)

33. How do consumers use signals to
assess quality?
Source: Gergaud & Livat (2007)

34. Prices as Quality Signals
 Following Bagwell & Riordan (1991)
 price signals respond positively to wine quality
 price signals respond negatively to increasing information
 Usage of two Datasets
 Main Wine Trade Fair & Gault Millau wine guide for Germany
 Small fraction of uninformed buyers
Source: Schnabel & Storchmann (2010)

35. Prices as Quality Signals
Source: Schnabel & Storchmann (2010)

36. esu mé
 R

37. Resumé
 Quality is signaled by prices
 Theoretically:
 the long run will increase the level of quality
 (decrease of low quality firms due to costs)
 Empirically:
 Price-quality correlations are weak and vary over time
 Different cultures, different price-quality perceptions
 Consumers know what they want to buy
 State of information matters

38. Thank you for your attention.
Questions?

39. REFERENCES

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