Investment in quality under asymmetric information with endogenously informed consumers

When sellers are privately informed about quality, signaling models can successfully explain an equilibrium correlation between prices and exogenous quality but do not account for incentives to invest in quality improvement. This paper shows that sellers may be motivated to invest in quality if consumers, though initially uninformed, may acquire costly information before buying. The equilibrium has the attractive feature that incentives to invest are greater the less costly it is for consumers to become informed. (C) 2000 Elsevier Science S.A. All rights reserved.