Quality Signaling, Advertising and Firm Numbers

Abstract

This paper investigates whether low-quality firms can pretend through advertising to be high-quality firms, which is a signal of product quality, when the number of firms increases. We assume that consumers remain loyal to high-quality firms after purchasing high-quality products and will therefore not patronize low-quality firms, which pretend through advertising to be high-quality firms. Our results indicate that the possibility of low-quality firms entering the high-quality market declines when the number of high-quality firms increases. Furthermore, the result of this paper suggests that if the number of low-quality firms is larger than that of high-quality firms, it may not be profitable for low-quality firms to advertise.