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Informational Equilibrium
John G. Riley
Abstract
If buyers are less well-informed about product quality than sellers, market prices will reflect average quality. Sellers of high quality products therefore have an incentive to engage in some distinguishing activity which operates as a signal to potential buyers. This paper explores the viability of such signalling or "informational equilibria." It is established that with a continuum of quality levels there is no Nash equilibrium. An alternative non-cooperative equilibrium concept is then developed in which potential price searching agents take account of possible reactions by other agents. It is shown that there is a unique "reactive" informational equilibrium.
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