When the truth hurts: ordinary selling price regulation in a monopoly
Date
2021-05-13
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Abstract
How does restricting firms to communicate a truthful ordinary selling price affect pricing and profits when some consumers are uncertain about product quality? In this thesis we analyze a two-period monopoly model to study the welfare effect of ordinary selling price (OSP) regulation. In the model, quality is observed by informed consumers who buy in the first period. However, consumers who arrive in market in the second period are not able to discern quality, but must infer it indirectly through prices. We first characterize the necessary conditions for OSP regulation to make the first-period price informative for second-period consumers. We show that OSP regulation has no effect when the proportion of uninformed consumers is high. This means regulation is ineffective when it would be most useful. We then compare the equilibrium outcome when OSP is effective to the equilibrium outcome in an unregulated environment. A simple welfare measure indicates that restricting firms to communicate a truthful first-period price has no effect on the uninformed consumers' expected surplus, but does create a deadweight loss from deceptive pricing in the first period. This deceptive pricing occurs because OSP regulations provide incentives for a low-quality firm to charge a high initial price when doing so enables it to earn excess profits in the second period.
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Keywords
Signaling, Monopoly, Ordinary selling price, Regulation
Citation
Sahragardjooneghani, B. (2021). When the truth hurts: ordinary selling price regulation in a monopoly (Master's thesis, University of Calgary, Calgary, Canada). Retrieved from https://prism.ucalgary.ca.