ENTRY AND QUALITY SIGNALING WHEN THE INCUMBENT IS INFORMED OF THE ENTRANT'S QUALITY

This paper focuses on competition between an incumbent and an entrant when only the entrant's quality is unknown to consumers. The incumbent knows the entrant's quality. The entrant's quality is assumed to be exogenously determined by nature, or endogenously chosen by the entrant itself. The exogenous model reveals the entrant's high price can signal its high quality, but entry deterrence occurs for the high quality entrant. Interestingly, the incumbent being informed of the entrant's quality generates an additional separating equilibrium in which the incumbent charges a higher price when the entrant's quality is relatively low, and a lower price when the entrant's quality is relatively high. Surprisingly, entry is facilitated. On the contrary to the exogenous model, the endogenous model result shows that entry deterrence still occurs for the high quality entrant with the incumbent being informed of the entrant's quality. However, in both settings, we find that the incumbent could not take advantage of its inside information of the entrant's quality.