Signaling Price Image Using Advertised Prices

Duncan Simester

This paper addresses the issue of retail price image by offering an explanation for how and when stores can use their advertised prices to signal the prices of other products in the store. A model of a two-product retail market is presented in which stores advertise the price of one product and customers do not know the price of the other product before selecting which store to visit. In a model with full customer information, stores with different marginal costs charge different prices for each product. When customers do not know each store's marginal cost type, an opportunity arises for each store to signal its cost type using its advertised prices. In such a model, additional equilibria exist In particular, stores with different costs may charge the same advertised price while continuing to charge different prices for the unadvertised product. Data from competing dry-cleaning stores is generally consistent with the model predictions. A number of additional properties of the equilibria are discussed and possible extensions to the model are proposed.

(Signaling; Pricing; Price Image; Advertising)